While listening to the conference calls of the three largest retail pharmacies in the U.S.; Walgreen (WAG), CVS (NYSE:CVS), and RiteAid (NYSE:RAD), I noticed one major recurring theme: higher generic drug prices are squeezing margins. This is not to say that these companies are doing poorly by any stretch of the imagination. In fact, the opposite is true, as all three reported quarterly results that surpassed Wall Street's expectations. However, with generic drug inflation a top concern for each of these companies moving forward, I feel as though it is only prudent to investigate the companies positioned to benefit from an increase in pricing.
For years, generic drugs offered a cheaper alternative for consumers when compared to name brands. However, recent investigational results presented at a Congressional hearing have shown that over one half of all generic drugs increased in price from July 2013 to July 2014, with ten percent of those doubling. Some were even stated to increase over 500%.
As the price of generic drugs rose, so did the stocks of many manufacturers of these knock off remedies. The reason? Higher prices lead to improved margins and a bigger number on each company's bottom line. Two of my favorite generic drug makers are Lannett Company (NYSEMKT:LCI) and Mylan, Inc. (NASDAQ:MYL).
Perhaps the more speculative of the two, Lannett Company has shown some of the fastest growth in the industry over the past year, with sales more than doubling. Earnings have also swung positive, as the company recently reported record first-quarter net income of $34.9 million, compared to a net loss of $6 million in the same quarter a year ago. Additionally, margin growth has been substantial over the last calendar year, surging 3,000 basis points to reach 77% in the first quarter.
The acceleration in both margin growth and profitability, a result of higher generic drug pricing, has not gone unnoticed by federal officials. Lannett has responded to a request for pricing information by the Connecticut Attorney General regarding the company's drug Digoxin. A U.S. congressional committee has also requested information regarding overall generic drug pricing, to which Lannett has already responded.
Aside from litigation, Lannett's future remains promising, as the $1.54 billion company currently has 21 ANDAs in its pipeline and continues to search for opportunities to vertically integrate and globalize its operations via strategic acquisitions.
The larger of the two companies, Mylan has a market capitalization of $21.60 billion and projected 2014 annual sales of $7.7-7.8 billion. Mylan operates with two segments: generics and specialty, which grew 15% and 30%, respectively, in the last quarter. Earnings per share have also grown aggressively over the last calendar year, up an astounding 41% on the heels of multiple new product launches. The impressive results come despite delays in two key product approvals for generic Copaxone and generic Lidoderm.
Mylan also recently acquired Abbott Laboratories' (NYSE:ABT) non-U.S. developed markets specialty and branded generics business, which is expected to be immediately accretive to earnings after closing in early 2015.
Additionally, Mylan has extended its partnership with the world's top hepatitis C drug maker, Gilead Sciences (NASDAQ:GILD), giving Mylan the non-exclusive right to manufacture and distribute Sofosbuvir as Sovaldi in low-income countries. The pair is also working on other agreements, including the exclusive distribution of the Sovaldi brand in India.
Perhaps the most encouraging factor about Mylan is the company's long-term view, as management has already set a 2018 EPS target of over $6. The stock will end 2014 up over 30% and remain within striking distance of its all-time highs.
Lawmakers And Rising Drug Costs
In an effort to support the consumers of generic drugs, lawmakers in both the House and Senate are proposing separate bills that, as described by Ed Silverman, "would require generic drug makers to pay additional rebates to state Medicaid programs for any medication that increases in price faster than the inflation rate."
The bills would surely put a damper on the growth of small companies such as Lannett that have been able to raise drug prices to expand margins almost at will over the last calendar year. As for Mylan, the effects of the bill would not be as significant, as the company relies more heavily on new drug launches than price increases to drive revenue growth. In any event, the passing of such a bill would surely put a damper on shares of both stocks, while providing some margin relief to the likes of Walgreen, CVS, and RiteAid.
It is yet to be seen whether either bill will be passed, as both legislatures are soon to become the minority in each of their respective legislative committees. With that said, I believe both Mylan and Lannett can continue to move higher in 2015, presuming he proposed legislation does not take place.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.