Four Catalysts Driving Drug Stocks

open spilled pill bottle on $100 bills

Drugs are big business. The opioid crisis puts the drug industry in the headlines minute-to-minute. In 2017, a record number of new drugs—109—was approved by the FDA. And that’s been good for drug stocks. More on those in a minute.

In the U.S. alone, drug manufacturing is a $160 billion marketplace, with slightly more than $30 billion in profit. By 2020, revenue is expected to top $170 billion, driven by patent expiration, the surging biosimilars market, M&A activity, and rapid growth in emerging markets.

Let’s take those one by one.

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Patent Expiration

Escalating revenues for pharmaceuticals is one big reason drug stocks look good right now.From the time the chemical entity is identified in the lab, a drug has 17 years of patent protection. Since it can take an additional 10 years before it can be tested on humans, most drugs have about a five-year real patent protection. Hundreds of drug patents will expire over the next six years, with a lot of revenue up for grabs, as you can see by the chart to the right. That creates a lot of volatility in the marketplace, but also provides opportunities for generics and biosimilars to be introduced.

Biosimilars

A biosimilar—also known as a follow-on biologic, or subsequent entry biologic—is an almost identical copy of an original product that is manufactured by a different company. They can be manufactured when the original product’s patent expires, and at lower costs. Express Scripts estimates that some $250 billion could be saved in the next decade (2014-2024) if biosimilars for 11 products, including Neupogen, Avastin, Epogen, Humira, Neulasta, Remicade and Rituxan, are approved. The biosimilar market is projected to reach $11 billion by 2021. Sanofi (SNY) received the first FDA approval for a biosimilar—Ademelog (insulin lispro injection), technically a follow-on biologic version of Eli Lilly’s (LLY) Humalog, last December.

Mergers and Acquisitions (M&As)

In Q2 2018, there were 61 pharma and life sciences deals that tallied $119.1 billion, a 160% increase over the previous quarter. Experts credit corporate tax cuts for the increased activity.

Contributor to our Wall Street’s Best advisories, Ben Reynolds, noted in a recent issue that Sanofi has joined in this trend, acquiring Belgian biotech company Ablynx and haemophilia-focused biotech, Bioverativ (BIVV).

Emerging Markets

According to www.in-pharmatechnologist.com, 80% of the expected growth in the pharmaceutical market is coming from pharmerging countries (developing countries where use of pharmaceuticals is growing rapidly). China is the standout, with experts foecasting that by 2022, its market will be as big as the top five European countries.

The healthcare industry is comprised of a number of segments: medical devices, cutting-edge biotech companies, technology-driven platform providers, healthcare services and facilities, insurance, managed care, and larger, more traditional pharmaceutical businesses.

A Turnaround Drug Stock

Sanofi (SNY) fits into that last category. In his recent recommendation, Reynolds had this to say about the company’s prospects:

“The company is headquartered in France and is a global pharmaceutical leader. Sanofi develops therapeutic treatments and vaccines. Pharmaceuticals account for 85% of sales, with vaccines generating 15%. Sanofi is a globally diverse company, receiving a third of sales from the United States, a quarter from Western Europe and the remainder coming from emerging markets and the rest of the world. The company operates in more than 170 countries around the world.

“For its first quarter, Sanofi earned $0.79 per ADR share, or 1.4% growth in constant currency. Revenue declined 0.4% to $9.71 billion. Sales declined 8.2% in the U.S. and 3.4% in its ‘rest of the world’ segment. Emerging market growth was strong at 8.3% and Europe saw sales inch up 0.5% year over year.

“Lantus, used to improve blood sugar control in adults and children with diabetes, declined 31% in the U.S. due to lower prices. The drug faced steep competition due to a biosimilar in Europe that caused sales to drop 9%. Lantus accounts for about 10% of Sanofi’s total sales.

“On the positive side, Sanofi’s Dupixent, a treatment for moderate to severe eczema, is forecasted to see peak sales of $3 billion. The drug is also being tested for additional possible treatments, such as asthma.

“Sanofi has also been active on the acquisition front. The company paid $11.6 billion for Bioverativ, and $4.8 billion for Ablynx. These acquisitions give the company access to the rare blood disorder market, which could be a high-growth category moving forward. Sanofi’s two purchases expand its reach in emerging markets and add new diabetes and skin cancer drugs to the company’s portfolio.

“Sanofi’s earnings have been up and down over the last 10 years, but that isn’t unusual for ADRs given fluctuations in currency exchange rates. The company expects to earn $3.28 per ADR share in 2018, which would be Sanofi’s best performance in the last decade. We expect earnings to grow at a 4% rate through 2023.

“Sanofi’s dividend has also varied over the last decade, but that is due again to currency exchange. The company has increased its dividend for the last 24 years in its local currency. The company pays an annual dividend every June, so investors would have to wait until next year to capture the payment. Shares have a recent yield of 4.27%.

“Over the last decade, Sanofi shares have traded with an average P/E of 18.3. At a current price of $42.48, the stock has a current multiple of just 13. If Sanofi’s stock were to reach its target multiple by 2023, shares could be looking at multiple expansion of 7.1%. This is the highest possible valuation expansion on our list. We forecast that Sanofi can offer a total return of 15.3% per year over the next five years.”

In its second quarter, the company beat EPS estimates by $0.02, posting earnings of $0.74 per share, and saw increases in its Specialty Care (14.1%) and Consumer Healthcare (4.1%) divisions. It also noted that six drugs are slated for potential FDA approval through second quarter 2019. Emerging markets revenues rose 5.2%.

And Wall Street continues to predict a turnaround for this drug stock, as new drugs such as Dupixent and Praluent come down the pipeline. Shares of Sanofi were just upgraded by Citigroup to ‘Buy’.

Yet, Sanofi is trading at a forward price-to-earnings multiple of 12.28. That’s considerably lower than the average industry P/E of 17.33—a nice discounted level at which to sample this drug stock.

Nancy Zambell

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