Investors in big pharma companies caught a breather this year, when patent expiration slipped from $55 billion in 2012 to just $30 billion this year. But the break is short-lived, given that the value of branded drugs losing patent protection will climb to $34 billion next year, and $66 billion in 2015. That suggests a big opportunity for generic-drug market-share leaders Teva Phamaceuticals (TEVA 1.01%), Mylan (MYL), and Actavis (AGN).
Debating earnings
To evaluate whether companies will continue to reward investors with buybacks and dividends, look at their operating margins -- their ability to turn revenue into profits. In addition to funding future dividends and buybacks, a strong operating margin fuels drug research, development, and acquisitions, too.
Thanks to improving sales of high-margin Epipen auto injectors only Mylan has been able to maintain its operating margin this year. Epipen revenue helped Mylan's specialty drug business grow 18.6% to $805.7 million in the first nine months of 2013.
Fewer generic product launches this year have been offset by specialty drug revenue at Mylan. But lackluster launches are weighing down profits at Teva and Actavis this year.
The lack of new generic products this year caused earnings per share to dip year over year in the third quarter at all three companies. Thankfully, they made sure analysts knew about their weaker product calendar this year, and Wall Street adjusted its earnings forecasts to reflect the challenge. As a result, all three companies have outpaced analysts' lowered projections in three of the past four quarters.
Surprise %
|
Dec. 2012 |
March 2013 |
June 2013 |
Sept. 2013 | |
|---|---|---|---|---|
|
Teva |
-0.80% |
1.80% |
0.00% |
0.80% |
|
Mylan |
1.60% |
0.00% |
1.50% |
2.50% |
|
Actavis |
3.90% |
7.00% |
0.50% |
0.00% |
Source: Yahoo! Finance.
Analysts are more enthusiastic for 2014 thanks to a slate of high-profile patent expirations. Thanks to better-than-hoped specialty drug sales and a high-profile launch of generic Copaxone, analysts have upped their forecast for Mylan's earnings to $3.39 per share from $3.34 over the past 90 days.
Since branded Copaxone is made by Teva, earnings are set to drop next year as Mylan cuts into sales. Teva generated $1 billion in revenue from Copaxone in the third quarter, or 21% of the company's total sales.
At Actavis, the $8.5 billion acquisition of drugmaker Warner Chilcott has analysts ratcheting up earnings per share projections to $12.82 next year.
| Teva | Mylan | Actavis | |
|---|---|---|---|
| EPS Trends | Next Year | Next Year | Next Year |
| 14-Dec | 14-Dec | 14-Dec | |
| Current Estimate | $5.01 | $3.39 | $12.82 |
| 7 Days Ago | 5.02 | 3.38 | 12.83 |
| 30 Days Ago | 5.16 | 3.38 | 12.44 |
| 60 Days Ago | 5.24 | 3.36 | 12.48 |
| 90 Days Ago | 5.26 | 3.34 | 9.4 |
| % Change from 90 Days Ago | -4.75% | 1.50% | 36.38% |
Source: Yahoo! Finance.
Debating valuation
Hopes for Mylan's specialty drug business and more generic launches next year have investors paying more for each dollar of the company's sales than at any point in the past five years. Actavis' price to sales ratio of 1.99 is also near five-year highs. But Teva's price-to-sales ratio is 1.70, the lowest in five years on worries over Copaxone threats.
Teva and Mylan appear richly valued at 29 times and 30 times trailing 12 month earnings per share, respectively. And if we remove one time third-quarter accounting charges tied to restructuring Actavis' prior acquisitions, Actavis is valued at 21 times trailing earnings.
Investors are timidly paying for 2014 projected earnings, suggesting accelerating generic product launches are under-appreciated. P/E ratios are just 8 for Teva,13 for Mylan, and 13 for Actavis.
Source: Yahoo! Finance and author's calculations.
That suggests an opportunity may exist at all three companies if they can deliver successful generic launches in 2014 and 2015. However, those launches will have a much bigger impact on Mylan and Actavis than Teva, since Teva's generic growth will be offset by lower Copaxone sales.
Launching generics and treating baby boomers
Teva may offer the most risk and reward, depending how fast Copaxone sales slide and how quickly Teva can cut costs ahead of the drug's expiration. But Mylan may offer the best balance of earnings leverage and valuation ahead of billions of dollars worth of product launches over the coming two years. Actavis is also intriguing given that its recent Wilcott acquisition may not be adequately rewarded.
But with aging baby boomers getting older and the Affordable Care Act increasing insurance enrollment, you may want to ask how much drug demand will climb in the years ahead. If current drug spending forecasts prove too conservative, all three of these companies could likely benefit.
