The Best in Generic Drug Company Stocks

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 |  Includes: AGN, IPXL, MYL, PRX, RDY, TEVA
by: Ron Sommer

Prescription pharmaceutical products in the U.S. generally are marketed as either generic or brand pharmaceuticals. Generic pharmaceutical products are bioequivalent (also known as biosimilar) of their respective brand products and provide a cost-efficient alternative to brand products. Brand pharmaceutical products are marketed under brand names through programs that are designed to generate physician and consumer loyalty.

Generic drug makers are hopeful that they will thrive over the next four or five years as some $60 billion in annual sales of branded drugs go off patent. Sandoz, the market leader for biosimilar drugs expects this market to grow to $20 billion by 2020, up from a current $250 million. There is also a second class of generic drugs, small molecule chemical drugs. Biological drugs are made of larger molecules than chemical drugs. Since generics of chemical drugs, which are made of small molecules, are relatively simple to copy, the market for generic drugs attracted a flurry of players.

The manufacturing and distribution of pharmaceutical products are subject to extensive regulation by the federal government, primarily through the FDA and the Drug Enforcement Administration (“DEA”), and to a lesser extent by state and local government. The Food, Drug, and Cosmetic Act, Controlled Substances Act and other federal statutes and regulations govern or influence the manufacture, labeling, testing, storage, record keeping, approval, advertising and promotion of generic drugs.

FDA approval is required before any “new drug” may be marketed, including new formulations, strengths, dosage forms and generic versions of previously approved drugs. Generally, the following two types of applications are used to obtain FDA approval of a “new drug.”

New Drug Application (“NDA”). For a drug product containing an active ingredient not previously approved by the FDA, a prospective manufacturer must submit a complete application containing results of clinical studies supporting the drug product’s safety and efficacy.

Abbreviated New Drug Application (“ANDA”). For a generic version of an approved drug – a drug product that contains the same active ingredient as a drug previously approved by the FDA and is in the same dosage form and strength, utilizes the same method of delivery and will be used to treat the same indications as the approved product – the FDA ordinarily requires only an abbreviated application that need not include clinical studies demonstrating safety and efficacy.

The pharmaceutical industry is highly competitive and is affected by new technologies, new developments, government regulations, health care legislation, availability of financing, and other factors. The principal competitive factors in the generic pharmaceutical market are:

  • The ability to introduce generic versions promptly after a patent expires;
  • Price;
  • Product quality;
  • Customer service (including maintenance of inventories for timely delivery);
  • The ability to identify and market niche products.

We are providing a list of six companies that we think are prominent in the generic pharmaceutical market. The leader and largest is Teva Pharmaceuticals (NYSE:TEVA). Sandoz is the number two generics company worldwide but is not listed here as it is a subsidiary of Novartis (NYSE:NVS). The other companies include Dr. Reddy’s Laboratories (NYSE:RDY), Impax Laboratories (NASDAQ:IPXL), Mylan (NASDAQ:MYL), Par Pharmaceuticals (Pending:PRX), and Watson Pharmaceuticals (WPI).

Ticker

Company

Recent Price

Price Chg. 52W

CFROI

EV/ EBITDA

ROE 12M

Market Value

RDY

Dr. Reddy's Laboratories Limit

33.15

40.00

17.42

24.14

21.50

5,610.03

IPXL

Impax Laboratories, Inc.

23.95

72.00

44.31

2.72

110.50

1,495.32

MYL

Mylan Inc.

23.35

28.00

6.48

38.97

7.00

7,225.56

PRX

Par Pharmaceutical Companies,

36.21

47.00

12.55

8.20

15.80

1,242.37

TEVA

Teva Pharmaceutical Industries

51.04

-12.00

12.55

14.85

16.10

45,884.96

WPI

Watson Pharmaceuticals, Inc.

57.16

50.00

8.06

18.70

7.20

7,007.82

Click to enlarge

Of this group, our favorite is IPXL. We believe that IPXL is undervalued with an EV/EBITDA ratio of 2.72 and is highly profitable based on free cash flow to invested capital. The company has a trailing PE of 5.6 and a forward PE of 8.0 based on FY10 earnings of $2.98. Gross margins are at 60.2% as compared to the five year average of 52.8%. EPS is expected to grow at a rate of more than 11%. IPXL has $358.4 million in cash and ST investments against no long term debt.

RDY is also a strong company showing CFROI at 17.42% and ROE of 21.5%. However, we consider an EV/EBITDA at 24.14X to be too high. RDY has a trailing PE of 27.4X and a forward PE of 24.3X based on earnings of $1.37. RDY has cash and ST investments of $221.8 million and long term debt of $117.3 million.

Mylan is a debt-laden company with a long term debt to equity ratio of 147.7%. The company is trading at 33.4X trailing earnings and 14.5X estimated FY10 earnings.

PRX is selling at a moderate EV/EBITDA ratio of 8.2X and provides a cash return on invested capital of 12.55%. The trailing PE is 14.9X compared to a forward PE of 12X. PRX has a strong balance sheet and shows no long term debt and $219.8 million in cash and short term investments.

TEVA is the big player in this space. We take a cautious view of TEVA. The trailing PE is a moderate 13.9X and the forward PE is 9.8X. Cash and short term investments total $1,284 million against long term debt of $4,110 million. Long term debt to equity is 18.7%. FY10 earnings disappointed and were less than analyst consensus estimates.

Watson does not throw off enough free cash flow, by our standards. The company’s ROE is also below our minimum. WPI is trading at about 16.7X estimated earnings and 30.9X trailing earnings. The company has about $265.9 million in cash and short term investments and reports long term debt of $1,162.1 million. Long term debt to equity is about 36.1%.

Disclosure: I am long IPXL.