The introduction of generics more than 30 years ago changed the pharmaceuticals business forever. These new drugs paved the way for cheaper alternatives to expensive patented drugs.
Not only did customers benefit from lower prices, but protections were provided to those innovators who had discovered the drugs in the first place. However, this situation seems to be changing rapidly with prices of generics across the board rising rapidly.
Pharmacies Feel the Pinch
Data from pharmacy-benefit manager Catamaran shows that the average cost incurred on a generic drug prescription in recent years is $41.88. This is significantly higher than the average cost of $14.21 for the 2005-09 period. Additionally, more than $100 is paid for a third or more of available generics.
As a result of this development, the likes of Rite Aid Corp. (RAD) and CVS Health Corp. (CVS) have seen their margins come under pressure. However, this has not impacted company performance drastically, with both of their recent results exceeding the Street’s estimates.
Legislation in the Works
The spike in prices has caught the attention of two legislators, Senator Bernie Sanders and Representative Elijah Cummings. They introduced a legislation called the Medicaid Generic Drug Price Fairness Act on Nov 20, 2014 which seeks to extend rebates that are currently applicable to brand name drugs to generics.
On the same day, the first Senate subcommittee hearing on higher generic prices began. This was a result of a request from the National Community Pharmacists’ Association. The Generic Pharmaceuticals Association had said at the time that the hearing was focusing on a small number of drugs. The association’s president said that price increases of only 10 drugs were being studied out of 12,000 available.
Possible Impact on Generics Producers
The passage of such a bill would certainly impact stocks to a varying degree. It is difficult to predict whether the bill will ultimately go through. This is because both the legislatures will be reduced to a minority in the legislative committees.
The Generic Pharmaceutical Association continues to claim that this kind of “sticker shock” is not taking place across the board. The association has said that “thousands of generics have seen significant price erosion over time” because of competition.
Meanwhile, major pharmacy companies have recently entered into partnerships or completed mergers and acquisitions. This gives them higher power when purchasing generics. CVS Caremark has partnered with Cardinal Health, Inc. (CAH). Meanwhile, Walgreens has completed the second phase of its acquisition of the UK-based Alliance Boots to form Walgreens Boots Alliance Inc (WBA).
Additionally, both RiteAid and Walgreens continue to face a negative impact on comparable store sales from generic drug introduction. For Dec 2014, RiteAid’s pharmacy comps improved 7.3% that included a negative impact of nearly 123 basis points from generic drug introduction.
Meanwhile, comps for Walgreens increased 9.2% during the same period. However, generic drug introductions in the last 12 months negatively impacted total comps by 1 percentage point.
Our Choices
Despite a rise in prices for some products, generics offer a cheaper alternative to patented drugs. Below we present three stocks which will gain from these trends, each of which also has a good Zacks Rank.
Mylan, Inc. (MYL) 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.
Mylan holds a Zacks Rank #2 (Buy) and has expected earnings growth of 10.7% for the year. The forward price-to-earnings ratio (P/E) for the current financial year (F1) is 13.54.
Teva Pharmaceutical Industries Ltd. (TEVA) is a global pharmaceutical company that develops, manufactures, and markets both branded and generic drugs, as well as APIs in North America, Europe, Latin America, Asia and Israel. Teva’s generic product portfolio includes tablets, capsules, ointments, creams, liquids, injectables and inhalants.
Teva holds a Zacks Rank #2 (Buy) and has a P/E (F1) of 11.11x. The Zacks Consensus Estimate for the stock has been revised from $5.02 to $5.11 over the last 30 days.
Both these choices are large players and usually launch several new drugs on a regular basis. This makes them somewhat immune to possible legislative action. Given these factors, adding these stocks to your portfolio would be a prudent choice.
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