BioPharma Stocks Worth Buying
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
While technology may be getting most of the the Street's attention, biotechnology should be viewed with similar optimism. As pharmaceuticals hit patent cliffs, generics and biosimilars are positioned for a boon. I find that Gilead (NASDAQ: GILD) and Amgen (NASDAQ: AMGN) are both worth diversifying in. Teva (NYSE: TEVA), as the world's largest generics producer, is attractive on more of a multiples perspective.
On a multiples basis, Gilead appears expensive. It trades at a respective 18x and 13.5x past and forward earnings with no dividend yield. Analysts currently rate the stock optimistically at a 1.9 out of 5 where "1" is a "buy." The stock is also fairly safe with 56% less volatility than the broader market. This contrasts with Teva, which has seen struggling sales in generics, but a very low multiple of 7x forward earnings. In addition, the Israeli firm also actually offers a dividend yield of 2.4% but this has been shaky over the years. Thus, Teva is more of a risky investment for BioPharma investors that are looking for turnaround potential. In my view, Teva is much more likely to outperform expectations than underperform the low bar that has been set. By contrast, Watson (NYSE: ACT), another producer of generics, trades at overly high multiples and doesn't even offer a dividend yield. ROA, ROE, and ROI are all in the low single-digits and free cash flow will come under pressure from rising competition. Although earnings growth has been strong over the past 5 years, the bar has been set too high against Teva's.
For Gilead, however, high multiples are worth dealing with, since 15.5% annual EPS growth is forecasted over the next 5 years. Assuming the company meets expectations, 2016 EPS will be $6.75. The historical 5-year average PE multiple is 17.8x, and, if that stays consistent, the stock would be worth $120.15 by 2016 - roughly double the current valuation. Discounting backwards by 10% yields a present value of $74.60, which offers more than a 25% margin of safety. ROA, ROE, and ROI are all in the high double-digits and further strengthen the upside story.
Free cash flow, the driver of all value creation, has also been on the upward trend. FCF for the TTM ending 2Q12 was $3.5 billion versus $3.2 billion in 2Q11 and $3.1 billion in 2Q10. That's a 6.3% steady CAGR with the latest FCF (ttm) being at a 7.8% yield to the market capitalization. Growth in margins and performance have caused Gilead to soar from ~$37 in late-2011 to nearly $60 today; I anticipate similar performance going forward.
Amgen, on the other hand, is a tougher cookie although still a buy. FCF for the TTM declined from $5.7 billion in 2Q10 steadily to $2.2 billion in 2Q12. Is now the time to get involved in a sinking ship? This same ship is at around a 25% premium to the historical 5-year average 14.4x PE multiple.
In my view, the answer is "yes" despite poor free cash flow trends. Management recently expanded more into biosimilars and acquired emerging market generic drugs. This will pay off big when the major pharmaceutical producers struggle to release drugs from scratch - a process inherently more difficult than what is the case in generic or biosimilar development. Acquisitions like Micromet are accretive to value because they target the high reward cancer market. KAI Pharmaceuticals was similarly attractive in helping to target the void left when Sensipar loses exclusivity rights in 2018.
At the same time, takeover activity has also expanded the firm's global footprint. It is now more exposed into emerging markets like Brazil. To mitigate risk, the company has also partnered with AstraZeneca in a deal that will lower variable costs while further speeding up development of brodalumab.
We can say something about the future based on the recent past. Second quarter performance was fairly strong with top-line growth of 9%. Strong returns in Neulasta helped to offset weakness in Epogen and margin declines. As a whole, EBIT gained 14% from improved efficiency. This has been a general trend that will help to mitigate any downside room for the stock. I thus, again, recommend buying shares.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Gilead Sciences and Teva Pharmaceutical Industries. 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.If you have questions about this post or the Fool’s blog network, click here for information.