The pharma sector experienced one of its most significant turning points 30 years ago when the Hatch-Waxman Act was signed into law, clearing the way for the launch of generic drugs which changed the pharma business forever. Since then, complicated regulations have been reinterpreted and revised.
Compliance has also increased for the industry. However, generic makers have also found new avenues of growth which make them a particularly viable investment choice.
Impressive Growth
The original legislation was intended to address the interests of innovative drug companies as well as generics makers. Protection was provided to innovators while they awaited patent approval. Additionally, a period was provided during which they could reap the fruits of their efforts.
After some initial hiccups, primarily caused by attempts to secure drug approval in haste, the generics segment has grown at a rapid pace. To illustrate just how fast this growth has been, data from market research firm IMS Health reveals that generics made up just 19% of U.S. prescription in 1984. This share had grown to 86% in 2013.
Geographic Expansion and M&As
Even though the Hatch-Waxman Act was a domestic legislation, its impact has been global. Global generics sales amounted to $260 million in 2012. According to IMS Health, this has occurred because of the need for cheaper medication in foreign markets as well as numerous patent expirations. This has helped generics firms expand geographically.
The global generics business is a fragmented one. However, the four biggest companies contribute over 40% of combined sales of 60 largest companies. This has been revealed in a report from market research company EvaluatePharma. This has been achieved by a series of mergers and acquisitions.
Inversion Wave
Another reason for such consolidation has been the series of foreign acquisitions undertaken to benefit from an easier tax regime. At 35%, the U.S. corporate tax rate is one of the highest rates in the world. A tax inversion involves the acquisition of a foreign company and subsequently adopting its home country’s domicile. Alternatively, the combined entity can create a holding company in a country whose tax rate is lower.
Last month, the U.S. Treasury Department made several change to tax regulations pertaining to such mergers. New regulations make it tougher to gain tax benefits from an inversion. As a result, some companies such as Chicago-based AbbVie Inc. (ABBV) have pulled out of such deals.
On the other hand, Mylan, Inc. (MYL) and Abbott Laboratories (ABT) have decided to continue with their $5.3 billion deal. Per the deal, Mylan will acquire Abbott Laboratories’ branded specialty and generics business in developed ex-U.S. markets. However, they have changed the terms of the transaction. This indicates that further mergers and acquisitions will continue in the sector.
Our Choices
Below we present three stocks which will gain from these trends, each of which also has a good Zacks Rank.
Actavis plc (ACT) is a specialty pharmaceutical company engaged in the development, manufacturing, marketing, sale and distribution of generic, branded generic, brand, biosimilar and over-the-counter (OTC) pharmaceutical products. The company, which was previously known as Watson Pharmaceuticals, Inc., became the third largest generics pharma company in the world following its Oct 2012 acquisition of Actavis Group.
Actavis holds a Zacks Rank #1 (Strong Buy) and has expected earnings growth of 40.2%. The forward price-to-earnings ratio (P/E) for the current financial year (F1) is 18.04.
Mylan, Inc. specializes in the development, manufacture, marketing, and distribution of generic, branded, and branded generic pharmaceutical products, as well as active pharmaceutical ingredients (APIs). The company, which operates in about 140 countries and territories, is one of the leading generic and specialty pharmaceutical companies in the world. The company derives the majority of its revenues from the generics segment.
Apart from a Zacks Rank #1 (Strong Buy), the company has expected earnings growth of 18.7%. It has a P/E (F1) of 14.93x.
Mallinckrodt plc (MNK) is involved in drug development, manufacturing, marketing and distribution. This includes both branded and generic specialty drugs, active pharmaceutical ingredients and agents used in diagnostic imaging. The company has two operating segments, specialty pharmaceuticals and global medical imaging. Mallinckrodt has a large generics portfolio with a focus on pain management drugs.
Mallinckrodt holds a Zacks Rank #2 (Buy) and has expected earnings growth of 39.6%. It has a P/E (F1) of 13x.
Data from IMS health show that 29% of expenditure on prescription drugs in the U.S. can be attributed to generics. With the advent of products like biosimilars, generics companies now have new avenues of growth. This is why these stocks would make good additions to your portfolio.
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