Once upon a time, pharmaceutical stocks were the darling of Wall Street. Today, many companies that research and develop new treatments are disappointing shareholders.
Ultimately, that was the loss of those optimists. As value investors, we are not afraid of bad news as long as we get compensated by low valuations. Two stocks suffering bad news, Eli Lilly & Co. (NYSE:LLY) and Johnson & Johnson (NYSE:JNJ) , are not cheap in light of their growth prospects. On the other hand, Sanofi SA (ADR) (NYSE:SNY) and Teva Pharmaceutical Industries Ltd (ADR) (NYSE:TEVA) are attractively valued relative to their peers.
Bad news for Eli Lilly
After running unsuccessful trials of an experimental drug that was meant to treat rheumatoid arthritis, Eli Lilly has stated that it is discontinuing trials. Eiry Roberts, vice president of autoimmune product development said, “While we are obviously disappointed by these results in rheumatoid arthritis, we continue to believe that tabalumab could have significant potential for patients in other disease areas.” This strategic decision seems to be justified by many reasons. First, the company is likely to incur huge losses arising from stiff competition from generic producers in this market. Second, the company plans to modify the drug and be used as a cure for lupus. Studies that were done on tabalumab in December showed that the drug will not be of any benefit in the search for a cure for rheumatoid arthritis. This development is not good news for Lilly as it was expecting growth to be stimulated by the development of new medicine since its Schizophrenia drug is losing its market niche.
Trouble for Teva
As competition is getting stiffer for Provigil, the earnings for Teva Pharmaceuticals Industries dipped by 19 percent as a result of dwindling sales of generic drugs. Profits dropped to $1 billion from $1.4 billion. The decline in profits is a result of many factors such as loss of patent protection on key products. Provigil had lost patent protection last year recorded a drop in sales by 93 percent. While the best-selling product Copaxone which treats multiple sclerosis faces competition from generics. Last year the Chief Executive Officer Jeremy Levin pointed out that the company plans to stimulate growth by concentrating on developing treatment for illnesses related to respiratory and central nervous system. He said “aggressive business development” is what Teva plans to use in its growth strategy which also includes venturing into new markets, acquisition and licensing deals. Recent data indicates that Copaxone sales increased by 14 percent in quarter which translates to $1 billion. Unfortunately, the drug faces competition from Gilenya, a new oral treatment product manufactured by Novartis AG (ADR) (NYSE: NVS).
Sanofi setbacks
Sanofi SA (ADR) (NYSE:SNY) expects a 5 percent dip in profits because generic products are expected to cut into Plavix blood thinner sales in 2013. Also, the expensing new machinery is likely to reduce the amount of profit generated. Chris Viehbacher, CEO, has adopted partnerships and acquisitions to aid in the company’s drug supplies and recover the losses that arose as a result of top selling products being outsold by generics. The company is planning to introduce new products that will stimulate sales growth. These include Aubagio and Lyxumia which were recently approved in the European markets. After the company announced the much awaited combination clinical trials with Lantus and that its bestselling drug will not proceed planned, its stocks dipped 4 percent. The tests were postponed to later unspecified date due to a technical hitch with Fix Flex Pen which was to be used to inject the combination. Alistair Campbell and Louise Hinds analysts at Berenberg Bank both said in a note, “Significant delays to the insulin combination do not bode well for this franchise.” Lyxumia does not seem to be commercially viable when it stands alone according to the analysts. Although profits for this year are set to drop, the company assured that it is still on track to attain its 2015 targets.
Scandal at
Johnson & Johnson
Johnson & Johnson (NYSE:JNJ) is facing up to 10,000 lawsuits after it designed an all-metal hip implant that allegedly failed the company’s own safety test. The company allegedly changed the testing protocol instead of fixing the flaw. Legal consequences could potentially cost J&J billions of dollars. Loren Kransky, a retired prison guard, filed the first of the myriad of lawsuits against the healthcare company, claiming defective design, failure to warn and negligent recall over the ASR XL hip he had replaced last year.
Even as J&J recalled nearly 93,000 ASR hip implants in 2010 once they reported the prosthetic had a 12% five-year failure rate, Australian data from last year concluded that the failure rate was actually of 22% after five years, with an increase to 44% when tested in a 7 year period of time. An epidemiologist at Dartmouth Medical School testified, “The ASR XL total hip replacement fails at a much higher rate than a typical hip replacement.” On the other hand, internal documents from J&J also show a failure rate of 37% in less than 5 years.
Valuations of troubled stocks
Finally, let’s consider the valuations of the stocks suffering bad news:
| Ticker | Company | P/E | P/S | P/FCF | D/E | EPS Growth Next 5 Yrs |
| MRK | Merck | 19.69 | 2.75 | NA | 0 | 2.7% |
| NVS | Novartis | 17.43 | 3.19 | 36 | 0.29 | 5.2% |
| GSK | GlaxoSmithKline | 16.01 | 2.69 | NA | 3.15 | 6.1% |
Yes, Eli Lilly is the cheapest stock based on static price-to-earnings valuations. Bear in mind that it should be cheap based on the news, and it should also be cheap based on analyst estimates for future growth. Hence, it is no deal. Instead, investors should consider Sanofi as a better alternative since it has a comparable price-to-earnings ratio, a comparable price-to-sales ratio, and positive growth estimates. Teva, arguably the cheapest stock on this list based on cash flows and sales. It is definitely cheaper than Johnson & Johnson (NYSE:JNJ), whose valuation makes little sense in light of its scandal.
Conclusion
Investors should consider Teva and Sanofi as buy candidates and should be perplexed and even entertained by Jonhnson & Johnson’s valuation.
The article Pharmaceutical Winners And Losers In Early 2013 originally appeared on Fool.comand is written by Bill Edson.
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