3 Undervalued BioPharma Stocks to Buy Now

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

In this environment of patent cliffs, many healthcare investors are naturally wondering where they can store their money. I find that the generic market is substantially undervalued right now and encourage buying shares in it alongside one of the biggest and safest pharmaceutical giants, Bristol Myers ).

Teva Pharmaceutical ): Cost Cutting, Scale, Pipeline All Under-appreciated

As major pharmaceutical manufacturers hit patent cliffs, the generic industry should get a nice influx of marketable catalysts. Teva, as the largest generic producer in the world, is well positioned to gain from this trend as it cuts costs to keep margins up. Morgan Stanley anticipates the company to trim its R&D budget from 2013 to 2014 while it consolidates manufacturing. The analyst forecasts Teva cutting up to $200 million in R&D from price-cost rationalization and that manufacturing efficiencies may yield around $400 million per year in savings after around half a decade.

And for good reason. The company was built up through a series of acquisitions and, at this point, contains a number of redundancies. Morgan Stanley estimates that it could theoretical shut down 40% of its facilities. In my view, however, the relatively new CEO, Jeremy Levin, is likely to take Teva down through a series of accretive takeovers. He comes equipped with a strong resume for his time at Bristol Myers where he grew the business through a "string of pearls" strategy (read: takeovers). This evolution at Teva is likely to be concurrent with the selling of unprofitable lines.

Going forward, there are several main value drivers. The respiratory and women's health business look particularly attractive as Cephalon is integrated to drive synergistic value. I am also optimistic about the PD1 catalyst for stem cells and cancers, which should, if nothing else, elevate multiples.

Watson Pharmaceuticals' ) Scale to Drive Appreciation, Bristol Safely Undervalued

As the other big generic producer, Watson also stands to gain BIG from patent cliffs. The question is if this has already been factored into the stock price. In my view, it has not been fully factored in. With Watson now the third largest producer of generics worldwide after the Actavis buyout, it has attained an economy of scale tapping into high-growth emerging markets that has yet to meaningfully lift shareholder value. The launching of Lovenox, Lipitor, and Concerta were particularly well timed for Watson to leveraged its newfound broad geographical exposure.

Watson has further showcased a strong ability to develop hard-to-manufacture drugs. This, according to Morningstar, has enabled the producer to generate abnormally high returns on capital. And even though the company has little vertical integration that will come up against Chinese competition, its newly large scale enables the spreading of costs over more assets. In addition, the company also produces its own drugs in urology and women's health that have received growing interest of late.

Although Actavis has tacked a good amount of debt, it generates operating cash flow that can pay off unwanted interest expenses at a reasonable time basis to knock the debt/capital ratio back down to 0.4x. Moreover, the Actavis takeover has made the company less dependent on oral contraceptives and granted it a better ability to source a greater diversity of inputs to expand margins.

If you want more safety, however, I would go for Bristol Myers. While ELIQUIS is largely speculative despite the strong showing at Phase III, YERVOY has nothing but under-appreciated upside right now. This catalyst targets the metastatic melanoma market, since it has already been successfully marketed in Europe. Greater applications in prostate and lung cancer promise even greater upside. At the very least, the +4% dividend yield should keep your bank happy.


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