As my fellow Fool Rick Steier points out, Teva Pharmaceutical Industries (Nasdaq: TEVA) has had a nice run. But to me, the future of the generic-drug business doesn't look as bright as its past.
There's no brand loyalty for generic drugs. You probably don't know who makes the generic drugs in your medicine cabinet; I certainly don't. The customer turns in a prescription to the pharmacist and gets whatever copycat version is on the shelves. The purchaser for CVS Caremark (NYSE: CVS), Walgreen (Nasdaq: WAG), or Rite Aid probably bought from the company that offered the best deal.
That kind of low-margin selling is a dangerous game to invest in. Sure, Teva is the largest generic-drug maker. Like Wal-Mart Stores (NYSE: WMT), its size gives it economies of scale that competitors like Novartis (NYSE: NVS) and Mylan (Nasdaq: MYL) may not be able to match. But the number of competitors is only increasing -- including branded-drug makers like Pfizer (NYSE: PFE) now getting in on the act. That's likely to cut into companies' market share and/or the price they can command.
Teva's branded drugs do provide some cushion from competition, but its top-selling Copaxone is itself under attack from generic-drug makers. If its patents aren't upheld in court, Teva could lose $2.8 billion in sales. That's 20% of its revenue, and presumably a larger percentage of profits, since the branded drug's margins are likely higher.
I'm not saying that Teva will go down the tubes tomorrow. In fact, I've pointed out the outstanding free cash flow that Teva produces year after year. But investors do have to make sure that they don't fall asleep in Teva's pool of cash. Drowning in competition wouldn't be pretty.
