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Credit Suisse (CS) has raised its pharmaceutical sector valuation targets and reiterated its "outperform" rating on four big pharmaceutical companies: Allergan (AGN), Eli Lilly (LLY), Merck (MRK) and Forest Laboratories (FRX). They did so in light of the improved market conditions.

We agree with Credit Suisse on the valuations and expectations for growth, except for Eli Lilly. The market has assigned a negative long-term EPS growth rate for the company, citing the uncertain future outlook aggravated by the fact the its pipeline will not start delivery sometime in the near future. AGN, MRK and FRX are stocks with reasonable growths, which is why we recommend these stocks as buys.

The lackluster economy and the patent-cliff have affected many pharmaceuticals, but Allergan has emerged as one of the fastest growing companies in the sector. It has tremendous expertise in the market of ophthalmic drugs, and intends to expand internationally. AGN has shown impressive revenue growth (Graph 1) over the years and has been expanding (Graph 2) its profit margins.

Graph 1: Revenue TTM

Source: Ycharts

Graph 2: Gross Margins

Source: Ycharts

Credit Suisse ranks the stock as outperform, based on the company's strong growth potential. Analysts expect a long-term earnings growth rate of 13%. Credit Suisse has a price target of $105, whereas the market estimate is $101.

Eli Lilly

Eli Lilly is a developer and manufacturer of pharmaceutical and animal healthcare products. Its pharmaceutical segment remains the largest, contributing 90% to total revenues. Aimed at improving its animal healthcare business, it acquired ChemGen Co and, the animal health business of Janssen in 2011. Eli Lilly trades at a forward P/E multiple of 13x and offers a dividend yield of 4.11%. LLY had announced in August the Phase 3 studies on the experimental drug Solanezumab, which is used to treat Alzheimer's disease. It did not meet expectations, however, the study did show a decline in the speed at which cognitive degeneration occurs. If LLY can build on this, it could prove to be a step forward in the treatment of the debilitating disease.

Graph: 3

Eli Lilly, currently, has a respectable gross profit margin of 79.53%, which is also its five-year average. It has a D/E (mrq) ratio of 38.43% (below the industry average) and an interest coverage ratio of 51x, which highlights LLY's financial strength and its ability to cover its obligations. Credit Suisse has assigned a price target of $53 for LLY, whereas the analyst mean estimate is $44.

Merck

MRK specializes in prescription medicine, vaccines, biologic therapies, animal health and so on, which it markets directly and through its joint ventures. Recently, as cited in our previous article, MRK signed a joint venture agreement with China's Simcere Pharmaceutical Group, with the aim of reducing costs and allowing the company to be in a position to make inroads into the Chinese market. Credit Suisse has a price target of $48, whereas the market estimates a target of $46. Analysts have assigned a long-term EPS growth rate of 4.5%. MRK offers a dividend yield of 3.71%.

Forest Laboratories

The company primarily focuses on the development and manufacturing of branded forms of prescription drugs. The diversified business has attracted institutional investment and provided reasonable revenue growth rate over the years. FRX's strategic focus seems to be establishing a diverse portfolio that not only provides a steady stream of revenues for the years to come, but also makes up for the lost sales of Lexapro. Lexapro was used to treat anxiety and depression; its patent expired this March. The drug had accounted for 59% of total sales in 2010. Moving forward, the company's $11 billion revenues are expected to drop by 25%. The company has, in fact, tried to bridge the gap in sales with its Bystolic project, but analysts are not as optimistic about it as the company. Another drug called levomilnacipran is in the pipeline, however, this drug, as well, is not expected to match the sales potential of Lexaprol.

On September 27, FRX and Pierre Fabre Laboratories announced that they had submitted a New Drug Application (NDA) for levomilnacipran, for the treatment of Major Depressive Disorder (MDD). The drug was jointly developed by FRX and Pierre Fabre, and the latter will be the active pharmaceutical ingredient (API) supplier. Credit Suisse has assigned the stock a price target of $42, whereas the market expects a price of $37. It trades at a forward P/E multiple of 22x and does not distribute its earnings.

Source: Credit Suisse Upgrades Pharmaceutical Sector: 3 Stocks To Buy, 1 To Avoid