CVS Caremark (CVS) and Walgreen (WAG) stand to benefit greatly from the expiring patents of major drug companies within the next two years. Drugs stores pay 90% less for generic drugs than for the branded drugs. Gross margins for drug stores average 48% for generics compared to only 8.9% for branded drugs. Prescription drugs account for 68% of CVS’s revenue and 63% of Walgreen’s revenue.
The expiring patents of branded drugs could result in an increase in the drug stores earnings of at least 20% which should last through 2013.
You can see from the charts that 10 major branded drugs have patents expiring in 2011 and 2012. The top section in light blue show patents expiring in 2011, while the darker blue section show patents that expire in 2012. Since the sales for 80% of them are in the billions, the drug stores have a lot of potential for increased earnings.
Lipitor was a best-selling drug for a few years for Pfizer (PFE) and accounted for 27% of its sales. Pfizer is buffering its patent loss with an agreement with Ranbaxy Laboratories, a generic manufacturer who is producing a generic version of Lipitor. The potential profit for the drug companies from Lipitor’s patent expiration is expected to occur in 2012 and 2013.
Plavix, which claimed the title as the second best-selling drug in the world had $9.4 billion in global sales in 2010. Plavix’s patent is set to expire on May 17, 2012. This drug is marketed jointly by Sanofi-Aventis (SNY) and Bristol-Myers Squibb (BMY).
CVS Caremark stock is already attractively priced as it is trading at only 1.3 times book value per share. It has a low forward PE ratio of 11.58 and a PEG of 1.21. CVS reports earnings on Thursday November 3. I would expect CVS to meet expectations and provide positive guidance for the next quarter. However, CVS CFO David Denton has been conservative when speaking about how much his company will benefit from patent expiration. He stated that pricing is very competitive and that he’s not sure what it will look like. He also stated that the percentage gain from patent expirations was not something that they analyzed in detail yet. Analysts expect that CVS’s earnings per share will increase 11% in 2011 and 14% in 2012.
Walgreen’s stock is also attractively priced – trading at only 2.05 times book value per share. It has a forward PE ratio of 10.57 and a PEG of 1.32. It enjoyed a 68.5% boost in earnings last quarter. Analysts expect Walgreen’s earnings per share to grow 17% in 2011 and to repeat a 17% gain in 2012.
Overall, both companies look to be a buy for the next 2 years. CVS and Walgreen should see a benefit to their earnings as a result of the patent expirations. Walgreen looks fine to purchase right now as it took a bigger hit in this year’s market correction. CVS looks overbought right now, so I would wait for a little consolidation in the stock and the market before pulling the trigger. I expect the market to pull back a little within the next 2 weeks before it tests the year’s highs by the end of December. I think that the next pullback in the market will be the opportune time to jump in to either stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
