Choosing Between a Mixed Bag and a Defensive Investment

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

While every healthcare investor wants to hedge against patent cliffs, I recommend not getting so caught up in these headwinds--after all, in many cases, the market has already factored them in. Below, I review several stocks that are exposed to exclusivity losses and argue that there is still some value to be had. To come up on top in this market, investors should eye the pipeline of not only the investment target but also competitor pipelines. Because you can have a great product; but, if data results are better elsewhere, why would patients choose your product? With this in mind, I review 2 BioPharma stocks.

A Mixed Bag

Amgen (NASDAQ: AMGN) is a so-so stock on the Street. First, it looks decent on a multiples basis--trading at a respective 15.1x and 12.1x past and forward earnings. Second, analysts are calling the stock a "hold." Free cash flow generation, however, has been terrific--growing from around $2.2 billion by the end of 2003 to $5.9 billion, or a CAGR of 13.1%. The free cash flow yield is also quite strong at 9.1%, and gross margins have expanded to 83.3%. Further, the balance sheet is very clean, as evidenced by the 3.6x quick ratio.

And operations have been better than expected in four of the last 5 quarters with an average beat of 14.5%. In addition, I am also optimistic about Amgen's drug targeting cholesterol-regulating PCSK9 gene to reduce LDL levels. Their candidate recently reported solid mid-stage trial results. However, there will be tremendous competition coming in from biosimilars. Amgen loses exclusivity for Neupogen in the US, a treatment for white blood cell deficiency, in December 2013, and this represents a major headwind. Top-line international Neupogen sales fell 15%--and this downfall was pronounced by Hospira's launch of Nivestem, a Neupogen biosimilar product. Erosion will become further magnified from the potential releases of short-acting filgrastim solutions--all in Phase III development--by Merck, Celgene, and Teva.

Going forward, it's a bit brighter. Sales in Neulasta, part of Amgen's Filgrastim franchise, has offset weakness in Neupogen so much that a global net sales gain of 1% was experienced in the third quarter. Weakness will further be offset by a focus on direct-to-patient solutions complemented by more direct advertising and investments in Enbrel. The sales force has been optimized to help drive greater ROA. Furthermore, Xgeva and its superior clinical profile has proved to be a big catalyst. A 25% share in accessible European markets has already been achieved.

An Undervalued Defensive Investment

In light of the challenging environment Amgen faces, it may be wise to put a bit of money in a company that has tremendous diversification. Johnson & Johnson (NYSE: JNJ) may be the ideal bet given that it also targets the consumer market in addition to the pharmaceutical and medical device markets. Over its history, the stock has more or less gone up and up while boosting the dividend distribution, which now yields 3.5%.

From a multiples perspective, J&J is a reasonable 12.6x forward earnings. Analysts forecast EPS growing by 6.4% annually over the next 5 years. Assuming expectations are met, 2016 EPS will come out to $6.61, which, at a multiple of 17x, translates to a future stock value of $112.37. Discounting backwards by 8% yields a present value of ~$76.50--in-line with consensus estimates. This means this highly defensive stock is more than 10% undervalued.

Furthermore, I like J&J's ability to be "forward-thinking." They are collaborating with Eli Lilly and Merck to develop a database that helps to speed up testing for experimental drugs. This long-term investment should speed up the path to commercialization but has yet to be appreciated by the market.

To complement your investment in J&J, you may be tempted to buy another high income-yielder: AstraZeneca (NYSE: AZN). Don't act too quickly. Though the firm trades attractively at 9.1x past earnings and offers a 6.4% dividend yield with a 58.3% payout, the business is in decline. Analysts rate it a 3 out of 5 where "5" is sell and forecast earnings declining by 3.5% annually over the next 5 years. And some even claim that AstraZeneca may be misleading investors that its naloxegol candidate met primary endpoints. Accordingly, I recommend avoiding the stock.

TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of AstraZeneca plc (ADR) and 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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