2 BioPharma Stocks To Buy, 1 To Avoid

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

In an environment of patent cliffs, what exactly are BioPharma investors to do? The key is to look at where the pipelines are strongest but have been obscured by exclusivity losses. Below, I review three companies: two of which I believe the bearish environment has overshadowed the fundamentals and one of which I believe the market hasn't been bearish enough.

Eli Lilly (NYSE: LLY) & Pfizer (NYSE: PFE) Both Undervalued

When you start to look at the multiples in BioPharma, it becomes clear that the market is overly bearish in the backdrop of patent cliffs. Pfizer, one of the strongest brands in the world, trades at 11x forward earnings despite an impressive dividend yield of 3.5% and 30% less volatility than the broader market. Lilly manages to trade at 13.4x past earnings with an even greater dividend yield of 4.1% and slightly lower volatility. What exactly are investors missing?

Quite a bit. For Pfizer, it comes down to several catalysts that have been ignored post the Lipitor exclusivity loss. Results were so strong in the third quarter than the company even got a note from the US government accusing the top drug manufacturer of abusing tax havens. I don't see much coming out of this accusation other than to drive investor interest to Pfizer's efficient operations. The pipeline has meanwhile shown to receive a nice tailwind in recent days: top-line data from the conjugate vaccine Prevenar 13, for example, met primary endpoints in all 13 stereotypes for adults between 18 and 49 years old.

In the more secular term, there are also promising developments diversified across multiple unmet needs. There's registration occurring for Eliquis for stoke prevention in atrial fibrillation, Viviant for osteoporosis, Tofacitinib for rheumatoid arthiritix, and Celebrex for chronic pain. Then there's Phase III development ofEliqiuis for venous thromboembolism, Tofacitinib for ulcerative colitis and psoriasis, Lyrica for peripheral neuropathic pain, and Inlyta for renal cell carcinoma adjuvant, among several others. As solid data emerge, I anticipate multiples elevating. Doubt tends to run rampant during patent cliffs, and, in Pfizer's case, this has overshadowed a strong track record that is likely to repeat itself in this new phase.

Lilly shareholders similarly have a lot to look forward to. Recent news from Phase IIb reported that the company's Empagliflozin drug was successful in reducing Type II diabetes patients's blood pressure. Insulin drug Analogue similarly had solid data in its Phase II study. But more promising than both of these two is Sola, which is likely to increase shareholder value even in the absence of FDA approval. 

Sola is aimed at slowing down Alzheimer's and may bring in somewhere between $5,000 to $10,000 per patient domestically. Drug manufacturers, like Vivus, have generated significant returns for shareholders just with the promise of releasing a revolutionary drug. Lilly's work in Sola may pay dividends in the form of IP research towards a cure or an alleviation of side effects - something that has yet to be appreciated by the market. Accordingly, I recommend buying shares and enjoying the high income stream in the meanwhile.

Johnson & Johnson (NYSE: JNJ) Not Worth The Price

Unlike both Pfizer and Lilly, J&J is quite expensive at 22.2x past earnings. The firm is forecasted for 8.1% annual EPS growth over the next 5 years. Assuming it meets expectations, it will generate 2016 EPS of $6.91. At a multiple of 16x, this translates to a future stock value of $110.56.

Discounting backwards by 10%, however, yields a fair value that is slightly below the current market valuation. Accordingly, from a value perspective, J&J is not attractive, especially in the context of an uncertain patent cliff environment. A series of recalls (infant's Tylenol, Benadryl, Topamax, and Invega, among many others) have put a doubt on management's ability to deliver positive results. 

In addition, the dividend may come under pressure from these recalls. Investors need to remember that dividend increases are not necessary indicative of something good; they could suggest that management lacks confidence in reinvesting the income streams into the business. In addition, if dividends are successfully classified as "earned income" for tax purposes, they will become more expensive than ordinary capital gains. Accordingly, I recommend holding out.

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.

blog comments powered by Disqus