3 Healthcare Stocks to Avoid or Sell

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

With several biopharmaceutical companies facing a series of patent cliffs and an overhauled healthcare system, the sector has hit low multiples on a historical basis. There are still instances, however, where companies have either run out of options or investors have become desperate to hit the blockbuster drug. To help you avoid these value traps, I provide three examples of overvalued stocks.

AstraZeneca's (NYSE: AZN) Cancellation of Buybacks Indicates Uncertainty Is Here To Stay

After AstraZeneca ended its share repurchase program with no prior notice, several analysts went ahead and reduced EPS estimates for this year and the next few years. Buybacks have totaled $2.4 billion in 2012, which was already down significantly from $6 billion in 2011. The justification was that management is aiming to improve its financial exposure. However, in my view this indicates that the company is really just uncertain about free cash flow generation in the near future.

Going forward, the stock carries significant risks and still warrants avoidance even after the market sell off. Management has made a series of cost reduction efforts that will help the company in the long-term, but reflect a lack of pipeline activity to sustain free cash flow, let alone grow it.

After all, the pipeline depends on R&D, especially given that it faces several exclusivity losses. Seroquel and Cresto are already open to superior generic competition. Limited efforts at targeting emerging markets, which are expected to see a dramatic increase in generic spending, expose AstraZeneca to significant downside. With that said, I am optimistic about the company's partnerships with generic and biopharma producers like Amgen

At around 7x past earnings, AstraZeneca may appear compelling; but many have, unfortunately rightfully, written the company off as a "downside story." Supply chain issues from the new Enterprise Resource Planning system have also overshadowed other promising catalysts, like the drug Fostamatinib and licensing arrangements.

Arena (NASDAQ: ARNA) & Vivus (NASDAQ: VVUS): Too Much Optimism With Too Little  Results

After the FDA approved Arena and Vivus' anti-obesity drugs, investors almost seemed to believe that good times were here to stay. However, Vivus' recent announcement about the EMA advising against the approval of Qsymia should provide a clear learning lesson. While the company has the ability to appeal the committee's decision, the announcement warrants more than the 12% decline it yielded on the market.

Vivus' product is actually a combination of topiramate and phentermine, which have increased the risk of birth defects. Accordingly, even if the drug is approved, it faces great uncertainty about being approved of by consumers. Even though Arena's Belviq ultimately has a stronger safety profile, overweight individuals are much more likely to seek dietary and mail-order solutions over prescriptions. And should European regulators make a decision contrary to US regulators for Qsymia, that will cast greater doubt on both FDA-approved Qsymia and Belviq. If Arena is successful in reaching out to European distributors, it could clear up much of this uncertainty.

All in all, anti-obesity drugs have not only become a stigma, but have also been the subject of PR disasters. Product recalls over past "solutions" have encouraged the overweight to seek other means to lose weight. That Arena and Vivus could trade as though their products will be blockbusters when they have yet to even develop a sales base is, ultimately, emblematic of the market's occasional tendency to act before it thinks.

Interested in Additional Analysis?

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TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of AstraZeneca plc (ADR). 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.

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