Brand spending for pharmaceuticals through 2016 is expected to be lower by as much as $127 billion due to patent expirations, also known as the "patent cliff." Consumers are expected to counter the loss in brand spending with higher spending on generic drug purchases. According to the general manager for pharmacy solutions at Silverlink Communications, George Van Antwerp, "Historically, over 90% of a brand's volume will convert to its generic alternative." That is a huge number, which could translate into huge revenue losses for many companies.
Big Pharma companies must spend intensive amounts of money on research and development to keep a successful pipeline of products coming to achieve profitability. Kenneth I. Kaitin, of the Centre for the Study of Drug Development at Tufts University, even went so far as to state openly that "I don't think there's a company out there that doesn't realize they don't have enough products in the pipeline or the portfolio, don't have enough revenue to sustain their research and development."
Investing in the pharmaceutical business can be rewarding to investors, however, and these companies may also be less affected by economic difficulties or market crashes. They also tend to pay solid, dependable dividends. Still, patent cliffs are messy, and litigation risks become yet another a potentially worrisome feature that an investor in one of these companies will encounter.
So how can investors get exposure to the healthcare industry while also minimizing the associated risks of patent cliffs and revenue-threatening lawsuits? They can invest in pharmacies such as Walgreen (WAG) and CVS (NYSE:CVS).
Here is a quick glance at the two companies:
Walgreen is the largest U.S. drugstore. The higher yielding company, unlike rival CVS, is also expanding overseas. Walgreen has also consistently raised its dividend for the last 25 years. The company has experienced troubles recently, however, due to declining revenues resulting from the aftershock of its dispute with Express Scripts (NASDAQ:ESRX).
Walgreen's standoff with Express Scripts developed into a mass migration of customers heading for CVS. CVS has been rapidly expanding of late, and claims it will be able to retain at least 50% of the business received in the fourth quarter from customers who were pushed over from Walgreen.
Investing in either company, or both, will provide an investor with exposure to the pharmaceutical industry. Walgreen is good for income, with a reputable track record of paying and raising dividends, currently paying a 3% yield. CVS is expanding and is more of a growth play, paying a lower dividend yield that will most likely increase over time. Both companies have solid balance sheets and would make good long-term investments.
The biggest concern with Walgreen is the loss of customers, who may feel angered and alienated after being pushed away during the Express Scripts dispute. A good amount of these customers will most likely come back, and there will always be new customers coming in, as the aging American population will demand more prescriptions.
I see Walgreen as a better buy then CVS at the moment. The company pays a better dividend, and also has a consistent track record of doing so. With Walgreen buying a stake in Alliance Boots, it also has an international presence and can now continue its growth in the United States as well as abroad.
Buying undervalued Walgreen now during short-term weakness would be a wise investment. The company recently achieved a record 3.7 billion in operating cash flow for Q3 and returned $371 million of it to shareholders. Sure, the Express Scripts dispute left a nasty black eye on Walgreen's reputation, but black eyes heal over time.
TheStreet also recently reiterated its Buy recommendation of the stock, citing:
attractive valuation levels, good cash flow from operations, largely solid financial position with reasonable debt levels by most measures, notable return on equity and increase in stock price during the past year. We feel these strengths outweigh the fact that the company has had sub par growth in net income.
Also according to TheStreet, "net operating cash flow has significantly increased by 50.16% to $1,847.00 million when compared to the same quarter last year. In addition, Walgreen has also vastly surpassed the industry average cash flow growth rate of -9.80%."
Walgreen may be facing some seriously turbulent short-term problems, but in the past it has been proven a winner. In my opinion, it will continue to be one in the long run. Picking up some shares of Walgreen or adding to a position will give investors exposure to the healthcare industry with a nice dividend attached. Margins will also increase from the flood of generic drug alternatives resulting from the upcoming patent cliffs. The company should remain profitable in good times and bad, as escalating demand for prescriptions rises against an aging American population.
Disclosure: I am long WAG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.