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These 3 Big Pharma Stocks Are Exceptionally Cheap

By Sean Williams - Mar 2, 2017 at 12:12PM

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No joke: These giant drug stocks have PEG ratios around or below 1, showing attractive growth prospects compared to their valuations.

For retirees and income-seeking investors, there are few industries that offer more promise than big pharma.

There's a lot to like about investing in some of the steadiest drug innovators. Their portfolios are often dozens of products deep, which provides the diversification investors would like to see when investing in a drug company. They also tend to have substantial pipelines and numerous development partnerships, meaning there are always new channels of revenue potential on the horizon. And most importantly, they tend to be very profitable, with most big pharma stocks yielding 2% or more.

Market data highlighted in a financial newspaper by a magnifying glass.

Image source: Getty Images.

One thing big pharma stocks typically aren't, however, is cheap. There's often a premium to be paid for companies that possess exceptional pricing power and juicy margins. This can mean paying 15 to 20 times forward earnings for a company only expected to grow at 5% per year (or less).

In other words, big pharma companies usually have PEG ratios (price-to-earnings-to-growth) that would make fundamental and value investors head in the other direction. A PEG of around 1 is usually considered attractively cheap, while a PEG that's closer to 2 would symbolize a company that's fairly valued. Some industry stalwarts, such as Johnson & Johnson and Novartis, have PEGs of roughly 3 right now.

These big pharma stocks are genuinely cheap

However, out of the 13 stocks that currently qualify as big pharma ($50 billion market cap, or larger), three have PEG ratios that are right around (or even below) 1! That's means there are big pharma stocks that are genuinely cheap. Could these big pharma stocks be worth a look by value investors?

GlaxoSmithKline: PEG ratio of 1.09

If you're wondering why on Earth GlaxoSmithKline (GSK -1.30%), a company synonymous with respiratory innovation, is so cheap, look no further than blockbuster drug Advair. Even though no generic version of Advair has hit pharmacy shelves, the pricing power of Advair has been adversely impacted since the COPD and asthma treatment lost patent protection. In 2016, constant currency sales of Advair fell by 15% to $4.33 billion. Mind you, Advair at one time was producing in the neighborhood of $8 billion in annual sales.

Now, here's the good news: GlaxoSmithKline has next-generation, long-lasting COPD and asthma therapies at the ready. Unfortunately, uptake of these products hasn't been without some speed bumps. Insurer coverage of these more expensive next-gen products was slow to take hold. Additionally, it wasn't easy to convince physicians and consumers to switch away from older products. Glaxo is finally beginning to see the results of its marketing efforts taking hold, especially with Breo Ellipta and Anoro Ellipta.

Doctor writing a prescription.

Image source: Getty Images.

Based on GlaxoSmithKline's full-year report released three weeks ago, Breo sales shot up to $770 million in 2016, while Anoro improved to $250 million. More importantly, the losses in revenue Glaxo is dealing with from the expected introduction of generic Advair are now being dwarfed by the growth from its next-gen COPD and asthma products, as well as its HIV drugs Tivicay and Triumeq. All told, new respiratory products accounted for $1.28 billion in sales, while the aforementioned two HIV drugs generated $3.34 billion in sales.

GlaxoSmithKline also reorganized its business via a major asset swap with Novartis, as well as improved its margins by reorganizing its supply chain. These billions in cost savings, along with its rapid growth expectation for growth in respiratory and HIV, could carry Glaxo to a higher valuation.

Shire PLC: PEG ratio of 1.04

The reason for Ireland-based Shire (NASDAQ: SHPG) being so relatively inexpensive compared to its peers isn't enitely clear. Shire completed the acquisition of Baxalta during 2016, which made it a bit tougher for investors to make transparent apples-to-apples comparisons. Shire has also moved off of the acquisition radar after acquiring Baxalta, and following changes to U.S. tax inversion regulations.

However, Shire has had little issue growing its top line, which is what should put it back on the radars of value investors.

Two lab researchers examining data.

Image source: Getty Images.

First and foremost, Shire is a leading provider of rare-disease medications. Even though there are rumblings in the U.S. Congress of reforming prescription medicine pricing, this would be extremely unlikely for the rare diseases that Shire targets. In other words, it's likely that Shire will see steady sales growth and exceptionally strong pricing power from its genetic medicines drug portfolio. In 2016, sales of its genetic disease drugs rose by 14% on an adjusted constant currency basis to nearly $2.7 billion.

A relatively new growth driver for Shire that investors should also be watching is its hematology operations, which were acquired through its Baxalta acquisition. According to Grand View Research, the global hemophilia market was valued at $9.3 billion in 2015, and is expected to climb to north of $15 billion by 2024. Shire could choose to use its cash flow to further bolster its hemophilia market share via mergers and acquisitions, or it could always consider selling its high-growth asset for a premium should a suitor come calling.

Let's not forget that Shire's merger with Baxalta is expected to result in at least $500 million in annual cost synergies, as well as double-digit sales growth through 2020.  This rare-disease big pharma stock is definitely worth a look for both growth and value investors.

AbbVie: PEG ratio of 0.79

But the cheapest big pharma stock of them all is AbbVie (ABBV -1.16%), with a PEG ratio of just 0.79.

Why no love for AbbVie? To begin with, AbbVie is heavily reliant on anti-inflammatory drug Humira, which is currently approved in 10 indications. At some point in the years to come, Humira is expected to face biosimilar and generic competition. With Humira accounting for 63% of AbbVie's sales, there's clear concern about where the company could be headed in the intermediate term.

Lab researcher using pipettes.

Image source: Getty Images.

The other issue for AbbVie is that its hepatitis C virus (HCV) drug Viekira Pak has been a major disappointment relative to Gilead Sciences' Harvoni. Viekira was introduced to the market with most HCV patients needing to take multiple drugs per day, which made it far less convenient than Harvoni. Even with a once-daily version of Viekira introduced, sales have languished. Viekira sales totaled just $1.5 billion in 2016, down 6.4% on an operating basis.

However, investors could be overlooking the incredible pricing power and diversity of Humira, as well as AbbVie's growing oncology pipeline. Humira wound up generating more than $16 billion in sales last year and shows little signs of slowing in 2017, with the drug maintaining its strong pricing power in the United States. As long as Congress has its hands tied with a number of major policy issues, drug pricing reform will continue to take a backseat.

Additionally, sales of blood cancer drug Imbruvica soared to $1.83 billion. Imbruvica was acquired when AbbVie purchased Pharmacyclics for $21 billion. Sales of Imbruvica have a real shot of eclipsing the $7 billion per year mark for AbbVie, which, when combined with its growing oncology pipeline, could get AbbVie and its shareholders over the bump when Humira does begin facing biosimilar and generic competition.

With a 4.1% yield, AbbVie is just as attractive to income investors as it is to value investors.

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