Healthcare and biotechnology stocks have put on another amazing show this year, with the closely watched iShares Nasdaq Biotechnology Index (NASDAQ:IBB) pushing higher by nearly 19% so far.
And certain subsectors, including generic and specialty drugmakers, have trounced even these princely gains. For example, shares of generic-drug specialist Actavis (NYSE:AGN) have exploded higher this year by almost 40%, as shown in the chart below.
Actavis' superb performance has been fueled, in large part, by acquisitions of a number of companies, including the reported $28 billion buyout of Forest Laboratories earlier this year. Even so, the company's skyrocketing share price may be the response from an overzealous market.
With that in mind, let's consider three reasons why Actavis' share price could struggle going forward.
Reason No. 1
Actavis is projecting a pro forma growth rate of 25%-35% in 2015 that may or may not be realistic. The company's optimism stems from rising sales of approved products and the potential commercial launch of up to six new drugs in the coming months.
Actavis certainly needs such stellar growth in order to justify its valuation on a forward-looking basis. Due to its spate of acquisitions, the company's shares are presently trading at a 12-month trailing price-to-earnings ratio of 498. The Street believes this number could fall to 14-ish next year, if Actavis can pull off its hectic business plan without a hitch.
Specifically, Actavis is busy integrating Forest Laboratories, Furiex, and Aptalis into the fold, increasing its investment in research and development by 37% from a year ago, and markedly upping its promotional activities for products already on the market. The market appears optimistic that Actavis can pull off these disparate activities simultaneously to create important cost savings and drive top-line growth for years to come.
That said, this is an extremely aggressive strategy in which any number of things could go wrong. Actavis could be staring down a huge P/E ratio next year if it is unable to achieve these lofty goals, putting the company's present valuation into question.
Reason No. 2
Although Actavis didn't provide specifics in the second-quarter report, management did note in its 10-Q that the company's cash position is significantly less than the roughly $7.71 billion listed previously, due to costs associated with the acquisition of Forest Laboratories. Going forward, Actavis believes it can generate upward of $4 billion in free cash by successfully integrating Forest, helping to replenish its depleted till.
This integration will be dependent on myriad factors, and it's not uncommon for mergers to run into major speed bumps along the way. In short, Actavis has a number of irons in the fire that will require large cash outflows that could further deplete the company's liquid resources.
Reason No. 3
Actavis shares aren't exactly cheap at current levels, and the market is clearly pricing in future growth. On book valuation basis, for instance, Actavis shares are trading at twice that of its generic-drug maker peer Teva Pharmaceutical Industries (NYSE:TEVA). Keeping with this idea, Actavis shares are trading at over six times trailing-12-month revenue, while Teva's are closer to only three times. All told, Actavis looks overvalued; it will need to live up to management's rosy growth projections to justify its present valuation.
Actavis' management has plotted an aggressive course to push the company to new heights, and so far, it's working. The Street's enthusiasm could nevertheless come crashing down if the company is unable to execute successfully on several different fronts at the same time. How Actavis handles the integration of three different companies, aggressively competes for market share for approved products, and guides newer products through developmental will be key for this stock moving forward. There are a lot of moving parts to Actavis' growth story that may make it hard for the company to live up to the Street's expectations.
George Budwell has no position in any stocks mentioned. The Motley Fool recommends Teva Pharmaceutical Industries. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.