3 Attractive Stocks in BioPharma To Buy

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

BioPharma stocks have been through quite a tumultuous period over the last few months. From healthcare reform to patent cliffs and corporate takeovers, their betas have been pretty high of late. Research has shown that riskier, high beta stocks tend to outperform their safer counterparts. But is the reward worth bearing the risk? With this question in mind, I review three healthcare stocks below.

Questcor Pharmaceuticals (NASDAQ: QCOR) Undervalued

After plummeting from around $50 to $17.50, Questcor has started to rise 50% from the 52-week low. This loss--resulting from Aetna's decision to limit coverage to an infant seizure and multiple sclerosis drug--has been overblown. Ladenburg Thalmann even upgraded their rating on the stock to a "buy" from the overreaction and put a price target of $33. With a 9.9x PE multiple, a PEG ratio of 0.3x, a debt-free balance sheet, and excellent free cash flow generation, Questcor's risk/reward is very compelling henceforward.

FCF of $165.8 million for the TTM ending 3Q12 represented a 11.1% yield against the market cap. Some have argued that Cerium Pharmaceuticals's Synacthen poses a threat to Questcor, but the latter's Acthar Gel has exclusivity on treating infantile spasms that lasts until 2017 in addition to other uses. It can treat nephrology and MS, so the cross-over value is substantial. Furthermore, management's introduction of its first-ever share repurchasing program and dividend distribution showcases confidence over the underlying fundamentals.

Investors, however, should closely follow the US government's investigation into Questcor's marketing. As one analyst rightfully noted, we can't quantify the amount of downside a negative finding could hold. The ambiguity in what qualifies as "misleading marketing", however, gives the company strong leeway to protect against a negative finding.

Why You Should Buy Forest Laboratories (NYSE: FRX), Mylan (NASDAQ: MYL)

Forest has gained 12.3% for the year to date, but it now trades at 25.3x forward earnings. Analysts rate it closer to a "sell" than  "buy", as growth starts to decelerate and even fall. In the second quarter, net profit fell from around $250 million to $21 million. With that said, the business does have some momentum. In the products category, use of Daliresp in pulmonology and primary care is rising with more than 300 thousand physician prescriptions in just 1 year of launch in the United States. New prescriptions have risen around 50% since the start of the year, and market share has risen by 70 bps.

If you recall, billionaire activist investor Carl Icahn ran a proxy contest against the firm last year. He attempted, and unfortunately failed, to get the business to itself. But he is now buying more shares--a classic Icahn strategy to gain more leverage against management. With the R&D budget expanding, investors are uncertain, but hopeful, about the future. This is especially true in light of the expiration of Lexapro, which, at its hight, contributed around $2.4 billion to the top-line. Some argue that Icahn is bringing down the stock through his legal battle against the CEO, but I believe this helps his long-term cause, which will create tremendous value for shareholders. From Genzyme to Biogen and ImClone, Icahn has had tremendous success in BioPharma, and I expect him to do the same for Forest.

I encourage investors, however, to diversify in businesses that will benefit from the patent cliff. Although Forest may get some upside from this, the best upside comes for the generic producers. Mylan trades at only 9.6x forward earnings and is rated a "buy" on the Street. Analysts forecast it growing EPS by 11.2% over the next 5 years. Assuming expectations are met, 2016 EPS will come out to $3.81. At a multiple of 13x, this translates to a future stock value of around $50. Discounting backwards by 10% yields a present value of $30.75. This is not an incredible premium to the prevailing price; but, it is factoring in what I believe are low growth assumptions. Mylan has skyrocketed FCF over the years, and this has been underappreciated by analysts. For this reason, I recommend buying on the expectation for positive earnings surprises. Coupling this with an expectation for greater activism at Forest Labs will provide, I believe, strong returns.


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