Can Fish Oil Help This Drug Giant Regain its Mojo?

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

AstraZeneca’s (NYSE: AZN) financial results have been on a downward spiral lately, as patent expirations have led to sharp declines in sales of its leading drugs.  In 2012, the company lost $4.5 billion of sales due to exclusivity expirations in various regions, a portion of which was attributable to its top-selling Crestor cholesterol drug.  In response, management went outside the company to try to protect its cardiovascular franchise, offering to buy tiny Omthera Pharmaceuticals (NASDAQ: OMTH) for roughly $323 million plus a contingent value based on the company’s future product success.  So, can investors profit from this union?

What’s the value?

Omthera recently submitted a new drug application to the FDA for approval of Epanova, a composition of omega-3 fatty acids that attempts to reduce severe hypertriglyceridemia, an elevated level of triglycerides in the blood that can ultimately lead to heart disease.  While a low-fat diet and exercise provide the best solution to avoiding heart disease, Epanova was shown to be effective for patients with severe conditions in two Phase III clinical trials in 2012.  If the company receives FDA approval for its indication, it will likely pursue approvals for less severe indications as well.

Obviously, Astrazeneca is betting big on the drug’s eventual approval and its own ability to sell the product through its worldwide network.  The potential market is large, with GlaxoSmithKline’s competing product, Lovaza, generating sales of £607 million in 2012, a 5% gain over the prior year.  Astrazeneca also sees opportunities to combine the drug with its own leading product offerings as a pre-emptive treatment against cardiovascular disease.

Astrazeneca could certainly use some good news, as each of its operating units reported lower sales totals in FY2012.  For the period, the company reported declines in revenues and adjusted operating income of 16.7% and 23.1%, respectively, versus the prior year.  Despite strong product offerings in its core cardiovascular and gastrointestinal areas, like its Crestor cholesterol and Nexium acid-reflux drugs, AstraZeneca couldn’t offset the negative effects of generic drugs on its overall profitability.

Fortunately, management has been engaged in forward thinking for some time, initiating restructuring plans that it hopes will generate up to $1.9 billion in annual cost savings.  The company is also looking to lower its research and development risks by partnering with leading competitors in its core competencies, including Bristol-Myers Squibb in the diabetes area.  With a goal of getting 40% of its future product pipeline from outside its own research laboratories, acquisitions will likely become an increasing area of focus for AstraZeneca over the long term.

The bad news

Unfortunately, the branded drugmakers are continuing to get squeezed by rising research and development costs on the one hand and price concession demands from large government payers on the other hand.  As such, investors are likely to do better by focusing on growing companies with exposure to both generic and branded segments, like Actavis (NYSE: ACT).  As one of the world’s top generic drugmakers with operations in 60 countries and a large distribution business in Europe, the company has ridden the rise of lower cost generic drugs to strong profit growth and stock appreciation.

In its latest fiscal year, Actavis reported a continuation of solid growth, with increases in revenues and adjusted operating income of 29% and 19.2%, respectively, compared to the prior year.  The company’s sales growth benefited from the blockbuster merger between Watson Pharmaceuticals and Actavis Group in October 2012, as well as the launches of generic equivalents to Concerta and Lipitor, which treat attention deficit disorder and high cholesterol conditions.  While the company’s profitability was negatively impacted by growth in its branded segment’s overhead, Actavis should be able to achieve economies of scale as it adds drug portfolios to the segment, including its pending acquisition of women’s health specialist Warner Chilcott.

The bottom line

Assuming completion of the deal between Omthera and AstraZeneca, an approval of Omthera’s drug would provide a nice upside to AstraZeneca’s cardiovascular franchise.  However, the drug giant still has to contend with lower potential future profitability due to governments’ pervasive cost containment programs that seem aimed at high branded drug prices.  While AstraZeneca is creating value through cost sharing with industry partners, Actavis’ generic focus, supplemented by niche positions in branded drugs, is a better long-term bet for investors.

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