The Market Is Too Pessimistic On These BioPharma Stocks...

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

When valuing companies, it's hard to feel confident about a winning stock pick. There are many moving pieces in any company, and this is especially true of biopharmaceutical producers. In the end, what really matters is if your outlook on a company bests the market's current expectation--this is what drives outperformance. Everything on top of that is just general economic growth and dividends. Below, I review several companies where I believe the market has failed to appropriately look at the future potential.

Abbott Laboratories (NYSE: ABT) & AbbVie (NYSE: ABBV): Which One Is Preferable?

Abbott is a major drug manufacturer that is facing a relatively bearish Street view. 12 of 18 reporting analysts rate the stock a "hold" or worse--one even says "sell." It’s important to consider Abbott's recent spin off, AbbVie. This company was spun off those the pharmaceuticals business--particularly, Humira, which comes off patents in 2016. Humira alone is expected to generate half of AbbVie's $18 billion in expected revenue. With a recent listing in both the S&P 500 and S&P 100, AbbVie is an important stock to follow. Fortunately, management has showcased confidence over the underlying fundamentals by increasing the dividend distribution by 6% to a yield of 3.3%.

I generally agree with the Street's assessment on AbbVie. Ironically, the reason for spinning off the risky pharmaceuticals business was to mitigate risk, but I believe the strategic effort has created one good and one bad company. The bad company retains the name "Abbott" and is engaged in only diagnostics, medical devices, and nutritional products. It should be noted that Abbott has marketing rights to several pharmaceutical products outside the United States, but it is limited exposure. By contrast, AbbVie is much more exposed to upside by the nature of focusing on future drugs.

Investors should be particularly optimistic about the Hepatitis C product Abbott is making. HCV is believed to kill 350 thousand individuals each year and affects 170 million currently. It is forecasted to grow at a much stronger rate than it has in the past few years due to the emergence of pegylated interferon therapeutics ("PIs). Vertex's Incivek and Merck's Victrelis, for example, (both PIs) have been responsible for making the CAGR positive over the last 7 years ending 2011. But these drugs still require weekly interferon shots, which is why Gilead's all-oral Sofosbuvir product looks particularly promising. This drug can be consumed once daily, and is better than AbbVie's twice-daily alternative. Even still, not enough attention has been given to Abbott's ABT-450, which cured 93% of hard-to-treat patients. It is moving into a Phase III trial, and the negativity related to competition from Gilead has, in my view, cut off upside too early.

Is The Street Also Too Bearish On AstraZeneca (NYSE: AZN)?

In my view, the Street is also overly bearish on AstraZeneca. The Street rates the stock a 3 out of 5 where "5" is a "sell" despite a compelling 9.7x past earnings multiple and 6% dividend yield. Part of the reason has to do with the expected low single digit EPS decline projected over the next 5 years, but, in my view, this has kept the market way too focused on the downside.

There are, after all, several reasons why investors could actually see upside from here. Recently, AstraZeneca's generic version of tamoxifen was found to cut the chances of recurring breast cancer if consumed for 10 years instead of the recommended 5 years. And this was complemented by overall survival data on Faslodex for breast cancer patients--the product improved the median survival time by 4.1 months for an injection of 500 mg versus 250 mg. Further, Naloxegol for opioid-induced constipation did not show any meaningful adverse events in two Phase III studies. And if AstraZeneca is really on the hunt for high-growth takeovers, it could help stem investor aversion to earnings erosion. An impressive $6.8 billion worth of cash stands on the balance sheet--more than enough to convert into a portfolio of prospective catalysts that could then be marketed to a larger sales base.

It is also noteworthy that the company is creating tremendous value at a 31.4% return on invested capital--more than double the industry average. The price/book ratio of 2.4x is also at a fraction of the 4.7x industry average. I thus strongly encourage buying shares of this beaten down British biopharmaceutical company, which has held flat and paid a nice dividend over the last 12 months in the absence of any catalysts. One could only imagine the shift in market sentiment through further pipeline advances.


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