By all available metrics, the healthcare sector has been performing admirably so far this year. Despite a weak second quarter, most healthcare stocks have seen their share prices climb by double digits for a third straight year.
While the sector at large has performed well of late, certain companies such as Actavis plc (ACT +0.00%) have still beaten the broader market by leaps and bounds, as the following chart shows.
Actavis's growth story centers on its aggressive merger and acquisition strategy that culminated earlier this year in a $28 billion deal for Forest Laboratories. By consummating this deal, Actavis also gained access to a promising new irritable bowel syndrome drug, eluxadoline, which Forest acquired through its own buyout of Furiex Pharmaceuticals.
With Actavis' share price pushing to new all-time highs, and a stunning 65% gain over the past year in hand, it's worthwhile to consider whether investors should continue to buy at these prices. With that in mind, here is a look at Actavis' valuation in the context of specialty-drug makers in general.
Is Actavis' now overvalued?
Within the specialty and generic-drug maker space, Actavis presently sports one of the highest market caps (see the following chart), which has even surpassed the industry's long-standing leader Teva Pharmaceutical Industries (TEVA 0.91%).
So is this skyrocketing valuation warranted? It looks to be: Actavis' market cap has appreciated and surpassed its peers because of its soaring revenues:
What might pop up as a red flag in some investors minds, however, is the company's jaw-dropping, trailing-12-month, price-to-earnings ratio of 492. After all, Teva's is a mere 17 and Mylan (MYL +0.00%) comes in at 32, and those companies are Actavis' chief competitors.
While a triple-digit trailing P/E ratio might be cause for concern outside the tech arena, you should bear in mind that this metric is being inflated by Actavis' string of acquisitions in the past year -- which have, in turn, generated the upswing in revenue.
On a forward-looking basis -- and presuming the company doesn't engage in yet another acquisition, Actavis' P/E ratio is expected to drop to roughly 14. Although Teva's forward P/E is projected to come in at 10 and Mylan's at 12, Actavis isn't unreasonably valued if this line holds moving forward, compared with its peers. And compared with the broader sector, whose P/E ratio has ballooned into the high 20s, all three of these generic-drug makers look fairly valued frankly.
So is it time to buy Actavis?
Actavis could easily beat the Street's revenue estimates for 2015, if eluxadoline gains approval sooner rather than later. With the drug now under review with the Food and Drug Administration, expect a commercial launch by the middle of next year, assuming approval.
What's key to understand for investors is that the IBS-D market is grossly underserved and thus a new drug should readily penetrate the market. Indeed, experts believe the drug could achieve $700 million in annual sales in as little as three years from launch.
So with double-digit, top- and bottom-line growth expected next year and a reasonable valuation compared with its competitors, Actavis is certainly worth checking out.
Foolish final thoughts
While Actavis' bull run isn't guaranteed to continue and may in fact fall if the broader market goes through a correction, investors should consider the possibility of a buyout in the near future. Given that Actavis has a strong clinical pipeline, a growing revenue stream from approved products, and a coveted Irish address, I wouldn't be surprised if Pfizer (PFE 0.19%) makes a play for the company if its pursuit of AstraZeneca falls through.
A Pfizer-Actavis pairing makes a lot of sense, after all. Pfizer is hard-pressed on the top-line front and is seeking a tax inversion to unlock latent value in its business. A buyout of Actavis could solve these problems almost overnight for the struggling Big Pharma.
Then again, the rumors about a potential Actavis acquisition have been swirling for nearly two years at this point, and it's been Actavis that has been the buyer, not the other way around.
