Invest in Affordable Care? 3 Rallying Generic Drug Stocks to Consider

Generic drug stocks are hoping the rollout of Obamacare can boost their bottom line. 

Earlier today, leading US pharmaceuticals distributor McKesson (MCK) agreed to buy German drugs wholesaler Celesio (OTC:CAKFY) for $8.3 billion, a deal that could give the American company access to $10 billion worth of generic drugs annually, according to Bloomberg.

Generic drugs are increasing in popularity in the US and accounted for 84% of total prescriptions in 2012, rising 8% from 2011 according to Health Cost Institute.

The generic drug industry has benefited from a recent wave of patent expirations on brand-name drugs, commonly referred to (within very, very specific circles) as the “patent cliff." 

Over the past two years, best selling products like anti-cholesterol medication Lipitor, blood thinner Plavix, and mental illness treatment Zyprexa have all lost patent protection, allowing generic alternatives to enter the market. And, in December, blockbuster antidepressant Cymbalta - which generates $3.4 billion in annual sales - will follow suit.

However, the market for generic drugs isn’t as lucrative as it once was. Pharmacy Times writes that while the annual sales value of the 40 brand name drugs that experienced patent expiration in 2012 was $35 billion, the drugs losing patent protection this year have a considerably lower annual sales value of $17 billion.

And despite reaching an all-time high rate of dispensation, the lower costs of generic drugs drove down US prescription drug spending by 1% to $325.7 billion last year. The New York Times reports that this is the first time drug sales have declined since research firm ISM Health began recording data in 1957.

Obamacare’s impact on generic drugs

Under the Affordable Care Act, aka Obamacare, generic drug usage could rise to 86-87% as insurers favor them over more expensive brand name options to keep premiums low. The healthcare legislation also includes a feature that could have long-term revenue potential for the generic drug industry - the Biologics Price Competition and Innovation Act (BPCI Act).

Read more: Hedge Funds Like These Six Medical Device Suppliers Amid Obamacare Rollout​

The BPCI Act provides a shortened approval pathway for drugs that are biosimilar or “highly similar” to FDA-approved biological products, which are drugs that are derived from animal, human, or microorganism sources (examples include allergy shots, gene therapy, and vaccines). 

According to Health Affairs, no biosimilars have been reviewed or approved by the FDA to date, but the department has released guidance giving companies insight into the regulatory pathway for these products.

Generic drugs manufacturers Teva (TEVA) and Apotex have already asked the FDA for more clarification, suggesting both companies are interested in pursuing biosimilar products.

Investment ideas

Healthcare stocks are really popular these days, as we already covered this month. We decided to mirror our earlier Obamacare piece by screening the healthcare sector for rallying stocks involved with generic drugs.

To begin, we constructed a universe comprised of stocks belonging to the drugs-related industries: generic, drug manufacturers - other, and drugs wholesale. We then screened that group for stocks that are rallying above their 20-day, 50-day, and 200-day moving averages (MA). This indicates that these stocks have strong upward momentum.

To further narrow down that group, we then looked for stocks undervalued relative to their cash flows, which is indicated by high ratios of levered free cash flow to enterprise value. Levered free cash flow refers to a the free cash flow that remains after a company deducts interest payments on outstanding debt. Enterprise value is a valuation measurement calculated by adding market cap, debt, minority interest, and preferred shares (excluding total cash and cash equivalents).

Levered free cash flow/enterprise values ratios exceeding 10% may indicate that the company, as a whole, is being undervalued.

We were left with three stocks on our list.

Click on the interactive chart below to see sales data over time.

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Do you think there's more upside potential in store for these stocks? Use this list as a starting point for your own analysis.

 

1. Endo Pharmaceuticals Holdings Inc. (ENDP, Earnings, Analysts, Financials): Operates as a specialty healthcare solutions company in the United States.

Market cap at $5.08B, most recent closing price at $45.12.

The stock is currently rallying 1.04% above its 20-day MA, 5.68% above its 50-day MA, and 25.49% above its 200-day MA.

Levered free cash flow at $827.26M vs. enterprise value at $7.70B (implies a LFCF/EV ratio at 10.74%).

2. AmerisourceBergen Corporation (ABC, Earnings, Analysts, Financials): Provides drug distribution and related services to healthcare providers and pharmaceutical manufacturers in the United States, the United Kingdom, and Canada.

Market cap at $14.74B, most recent closing price at $63.83.

The stock is currently rallying 2.45% above its 20-day MA, 7.30% above its 50-day MA, and 19.65% above its 200-day MA.

Levered free cash flow at $1.46B vs. enterprise value at $14.29B (implies a LFCF/EV ratio at 10.22%).

3. Teva Pharmaceutical Industries Limited (TEVA, Earnings, Analysts, Financials): Develops, produces, and markets generic drugs; and proprietary branded pharmaceuticals in various therapeutic categories and active pharmaceutical ingredients worldwide.

Market cap at $34.11B, most recent closing price at $40.18.

The stock is currently rallying 2.60% above its 20-day MA, 3.78% above its 50-day MA, and 4.47% above its 200-day MA.

Levered free cash flow at $4.71B vs. enterprise value at $44.90B (implies a LFCF/EV ratio at 10.49%).

 

(List compiled by Mary-Lynn Cesar. LFCF/EV data sourced from Google Finance. Quarterly sales data sourced from Zacks Investment Research. All other data sourced from Finviz.)

 

Analyze These Ideas: Getting Started

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Dig Deeper: Access Company Snapshots, Charts, Filings

Endo Pharmaceuticals Holdings Inc. (ENDP, Chart, Download SEC Filings) AmerisourceBergen Corporation (ABC, Chart, Download SEC Filings) Teva Pharmaceutical Industries Limited (TEVA, Chart, Download SEC Filings)

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