3 Stocks to Consider Buying as Patent Cliffs Loom
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
As several biopharmaceutical players hit patent cliffs, there will be increasing pressure to release the next big "product." Fortunately, Johnson & Johnson (NYSE: JNJ), Watson (NYSE: ACT), and Mylan (NASDAQ: MYL) have all seen fairly strong returns of late. Watson and Mylan are up 19.8% and 15.5%, respectively, from solid performance and a greater trust by the market that the next big "product" is indeed coming to a Rx store near you.
Mylan, for example, has prepared itself for the wave of exclusivity losses by signing a long-term agreement with Pfizer to manufacture generics in Japan under the latter's name. This market is the third largest in the world for generics and thus represents an attractive market to penetrate and build a sustainable recognition. As the number of generics grow, a field that Watson has historically dominated in, Mylan has the potential to increase visibility and attract investors. The firm, for example, recently gained FDA-approval to market Singular, a $1.4 billion asthma and allergy drug created by Merck.
At the same time, Mylan is also a prime beneficiary of the Affordable Care Act. Federal health programs require generic prescriptions as a way to save money, so the obvious implication is that more free cash flow is heading in Mylan's direction. Despite all of the strong tailwinds, the firm is still forecasted for around 750 bps less in annual EPS growth over the next 5 years. I believe that this low bar will be exceeded and help generate high risk-adjusted returns in the process.
The story at Watson is ultimately very similar. My main concern with this producer is that it is more expensive at 10.2x forward earnings and is right around its 52-week high. ROA, ROE, and ROI are all in the low single-digits - abysmal returns that will attract investors into safer BioPharma stocks, like Pfizer. At Pfizer, the dividend yield is high, volatility is low, and the expectations can be easily exceeded. It should thus not be surprising that analysts prefer the iconic Lipitor creator over Watson. Should we expect this to change in a few years?
The firm recently gained FDA approval for lidocaine topical patch 5%, which a generic version of Lidoderm. Its diversification in categories including cardiovascular, nervous, and hormonal conditions help to mitigate risk, but they also mitigate upside. Watson has done well in executing over the past few years, so investors have already seen much of what is to be offered. Accordingly, I recommend holding out.
Even J&J doesn't have the same upside as Mylan. It trades at a respective 21.8x and 12.5x past and forward earnings with a strong dividend yield of 3.6%. It's the largest drug manufacturer out there with one of the most secure economic moats. However, at this point, there isn't much upside left in an investment.
Over the past 5 years, EPS has declined by 1.4% annually, yet a 6.7% annual return is expected over the next 5. Assuming that the company meets expectations, it will generate 2016 EPS of $6.64. At a 15x multiple, this translates to a future stock value of nearly $100. Discounting backwards by 10% yields a present value of $61.84, which means the firm is already trading at a premium. On the other hand, whle being overvalued does not mean that it is a poor investment. Growth investments can offset the premium, and, indeed, I forecast J&J being worth $100 per share by 2016. Add in the dividend yields, and you have possibly a solid 10% return.
Accordingly, I recommend J&J only for defensive players and Mylan for investors looking for high growth. Watson lies somewhere in between in terms of risk/reward, so I urge some diversification. The key to earning in this market is to take advantage of the upcoming patent cliffs by not only betting where the big catalysts will be coming out (J&J's acquisition with Synthes would provide it with a view to introduce to large patient populations) but to bet on the generic market at large.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Johnson & Johnson. Motley Fool newsletter services recommend Johnson & Johnson. 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.