Teva Pharmaceutical Industries Ltd., Actavis plc, and Mylan Inc.: Generic Drug Companies to Buy or Avoid?

Teva Pharmaceuticals (NYSE: TEVA  ) , Actavis (NYSE: ACT  ) , and Mylan (NASDAQ: MYL  ) are all generic drug manufacturers, and with the exception of Teva, stock performance within this class has been tremendous over the last two years. Looking ahead, is it possible that generic drug stocks are a continued buying opportunity?

The patent cliff
According to a February 2011 research report by Evaluate Pharma , approximately $133 billion in brand drug sales would lose patent protection in a six-year period between 2011 and 2017. This period has been labeled the patent cliff by many who follow the sector.

There have been many effects as a result of the patent cliff. First, large pharma sales have suffered or are expected to suffer in the coming years. Second, the cliff has forced large pharma into big acquisitions and record spending in R&D. Third, we've seen a paradigm shift and new leaders in the sector emerge, such as Gilead and Celgene. Lastly, generic drug manufacturers have thrived.

2014: An exceptional year ahead?
The last effects are the ones that aren't often discussed, but could be most lucrative for investors. To explain, take a look at the chart below, showing a top-nine list of blockbusters-only that are expected to lose patent protection in 2014 alone

Company

Drug

Annual Sales

AstraZeneca

Nexium  

$4.9 billion

Eli Lilly

Cymbalta

$4 billion

Teva

Copaxone 

$4 billion

AstraZeneca

Symbicort 

$3.1 billion

GD Searles

Celebrex 

$2.5 billion

Novartis

Sandostatin 

$1.3 billion

Merck

Nasonex 

$1.3 billion

AbbVie

Trilipix 

$1.1 billion

Eli Lilly

Evista 

$1 billion

Total

 

$59.2 billion

Source: FiercePharma.

In 2014 alone, more than 40% of Evaluate Pharma's estimated $133 billion in brand drug sales will lose patent protection. Thus, 2014 is the biggest single year of the patent cliff, at least for generic drug manufacturers and pharmacies.

Moreover, if we look further, Abilify ($4.6 billion) and Gleevec ($4.3 billion) are expected to lose patent protection in 2015 , then Crestcor ($6 billion) and Benicar ($2.5 billion) in 2016 .

Hence, it is going to be an exceptional year for generic drug manufacturers, especially Mylan and Actavis.

Winner and losers of the patent cliff
In 2013, generics were actually a weakness for Mylan, as North American generic sales fell 14% in the company's third quarter . The company went through a transition where it lost generic exclusivity, and lost blockbuster generic rights to Actavis. With that said, Mylan has seen strength in global generic sales, rising 11% in its last quarter, and judging by analysts, the company is expected to have a much better year as more generic drugs hit the market.

Actavis has been the big winner of the patent cliff. Its pharma business grew 69% in its last quarter, and the company notes that much of that growth was due to new generic launches such as Suboxone, Nucynta, Lamictal, and Lidoderm, which were all big patent expirations in late-2012 to 2013. Looking ahead, Actavis is expecting far more blockbuster generic launches, as analysts expect sales to grow 22% this year.

Teva is the wild card, because although generics have done well, the company also faces the challenge of losing patent protection on its single largest drug Copaxone. As fate would have it, Copaxone has been a reason for constant concern among shareholders, as it accounts for 20% of the company's total annual sales.

Is it time to buy generic-drug makers?
Like all industries, every company presents different levels of value.

Unsurprisingly, Teva is expected to post a 1.5% year-over-year revenue loss in 2014. While it may be too early to gauge the full effect of losing patent exclusivity on Copaxone, a 1.5% loss seems reasonable, and likely implies growth in the company's generic business. At 1.7 times sales, Teva is the cheapest in the space, but because of Copaxone, the company will fail to produce significant growth during a time when generic drug makers should thrive. For this reason, it's hard to be bullish on Teva.

Mylan trades at 2.4 times sales and is expecting revenue growth of 12.4% in 2014. Actavis, while more expensive at 3.8 times sales, is also expected to grow significantly faster at 22% in 2014 . Therefore, either Actavis or Mylan look like solid investment opportunities based on growth. Both trade at near 13 times forward earnings, thus are relatively cheap, allowing investors to take advantage of a hyper-growth industry with attractive valuations. Essentially, these two stocks should thrive in 2014, and beyond.

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