Do Major Drug Manufacturers Have Room to Grow?

Chris is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Major drug manufacturers are literally a market sector unto themselves. With valuations that frequently soar into the $50 billion level and beyond, these companies have already grown to incredible proportions. But can they grow further still, or is the best they can do to keep going along a steady path?

Never underestimate a dark horse

AstraZeneca (NYSE: AZN) is a Swedish and British company, which automatically puts its epicenter into the mature European marketplace. In addition, it's hard to put much growth into a company that is already the fifth largest in the world by prescription drug sales volume. Furthermore, AstraZeneca already operates in more than 100 countries, meaning it's running out of new countries to explore.

However, there are three good reasons AstraZeneca can still grow heartily in sales volume and share price:

1. The established markets aren't everything.

86% of the company's sales happen in Western Europe, North America and Japan. As additional markets develop, AstraZeneca is positioned to target these markets. They already do a large portion of their product testing in less-developed nations.

2. The number of settlements resulting from purported unfair promotion of AstraZeneca's antipsychotic drug Seroquel is dying down. However, the market is still fearful of the possibility of further backlash, evidenced by how the company is trading at around 12 times its earnings in spite of a 21% profit margin.

3. The company is working to develop a drug currently labeled AZD5423, which is intended to treat respiratory diseases such as COPD. With more than 120,000 Americans alone dying from this illness every year, there is a huge potential market. Given AstraZeneca's previous successes in getting products through the trial stages and the drug's current stage II, there is a reasonable chance of its success.

While there's no guarantee, I would suggest keeping a close eye on AstraZeneca because it has serious growth prospects.

Getting the public's help works

Eli Lilly & Co. (NYSE: LLY) is the biggest psych drug manufacturer and distributor on Earth, as well as having several firsts in its history. But history isn't future growth, despite Lilly's tendency to do well at almost everything. This is a company that has produced dozens of highly successful drugs, that continues to churn them out, and that even made Elizabeth Arden cosmetics profitable.

Lilly certainly has the cash flow to expand, turning in 20.5% profit margins on a trailing $22 billion in sales. Also, Lilly's tendency to rapidly cycle through management that causes the company to take losses is also a good insurance policy against negative practices. Beyond these, Lilly has narrowed its focus since the beginning of the century and worked to cut costs and expand on its research capacity by developing relationships and securing public funding through joint efforts with organizations such as the European Commission. The fact that Lilly is only trading at around 13 times earnings also bodes well for its growth potential.

Watch the company that rules a niche

Zoetis (NYSE: ZTS) has targeted an interesting niche: pets and livestock. While Zoetis is a public subsidiary of Pfizer, it is operating with general independence despite the larger company's 83% controlling interest in the junior company. As the smallest of the major drug makers, with a market cap of "only" around $16 billion, there is definitely room to grow. Three major factors should be kept in mind before you write off Zoetis as a low-growth company:

1. The company is making significant strides into the Chinese and southeast Asian markets, which are hotbeds of economic growth and sport a burgeoning middle class.

2. The targeting of livestock and pets is powerful on two fronts. On the one hand, many people are willing to invest highly in the health of their pets. Beyond this, farmers of all sizes recognize that the well-being of their animals is important to their business. This is a hidden contributor to the prices of commodities such as head of cattle and pork bellies, as well as a significant influencing factor on worldwide food supplies.

3. Zoetis has existed in one form or another since the 1950s, but the company only went public in 2012. While certain recent IPOs have produced less than stellar results, Zoetis is past the point where early adopters are clamoring for its shares the way they do on a stock's first few days. I won't recommend a company trading for 35 times earnings, but I will suggest that you keep an eye on Zoetis.

The bottom line

The verdict is in: there is a huge degree of potential for companies that are already massive. There is usually a large market for companies to grow within, and often a big company has the cash flow to navigate this market successfully. When you can find a good deal on a great company, don't hesitate just because the firm is already huge.

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Chris Hodge has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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