Value Investing

Valeant, Celgene, Actavis: My Top Three Pharma Stocks

My Top Three Fabulous Pharma Stocks by Chuck Carnevale, F.A.S.T. Graphs

Introduction

I am a fervent believer that investment decisions should be made based on the relative merits of each individual investment under consideration.  However, my anecdotal observations and experience suggests that many investors do not embrace that approach.  This is especially true regarding investment decisions on common stocks.  Instead of focusing on the opportunities and valuations available from select individual businesses, many investors are obsessed, and I allege blinded by generalized views or beliefs about the overall market and/or the economy.

For example, in a recent article found here I postulated about reasons why carefully selected growth stocks might benefit retired investors under certain circumstances.  In the article I presented a few examples of high-quality fast-growing businesses that I considered fairly valued based on their earnings growth rates.  Unfortunately, and as I expected might happen, a comment made in the article rejected my carefully selected growth stock research candidates based on what I believe are misguided views about the market in general.  The comment is included in its entirety as follows:

“I like growth stocks but not when the market is at all time highs and way overpriced as it is now. Just for example, the Russell 2000 is at a P/E of 40 and P/B of 4 – hardly compelling valuations.

Many growth stocks should be sold short here and that is what I am doing. When the market tanks (soon) I will close out my shorts and go long on some of the growth stocks I like.

Making a decision on buying a stock without looking at its relative valuation and that of the market is a dangerous proposition and one I am not interested in.”

To clarify my position, I offer the following elaboration and critique regarding why I found this comment concerning.  First of all, the reference that the P/E ratio and price-to-book ratio of the Russell 2000 were at all-time high valuations was not relevant to the valuations of the individual research candidates I presented.  Each of the companies I presented was offered because I believed their valuations were in alignment with their past, present, and most importantly, their future earnings potential.  The valuation of the Russell 2000 was therefore irrelevant.

The second paragraph also offered a generalized view of growth stocks and suggested that they should be sold short.  But again, I don’t believe this statement relates specifically to the candidates I offered in the article.  Then the bold prediction was made that the market would tank soon, which of course, is impossible to accurately forecast.  However, the comment also indicated that this could be timed to perfection by closing out shorts and then investing in growth stocks that were favored.  Again, I contend that this is impossible to time or predict.

Finally, the comment suggested that buying a stock without looking at its relative valuation and that of the market was a dangerous proposition.  Of course, I vigorously agree that investors should evaluate the valuation of the company, but only based on its specific fundamental merits, regardless of the valuation of the overall market.  I elaborated on my belief that it’s a market of stocks and not a stock market in a recent article found here.

The Pharma Sector Powerful Demographic Forces Support Growth Potential

Therefore, I was motivated to offer this follow-up article on growth stocks for retirement portfolios by offering three attractive looking growth stock research candidates in the Pharma sector.  Thanks to the demographic forces of an aging population, I contend that the Pharma sector offers enormous growth potential that is independent of the general economy or the stock market.

As I indicated in my previous article on the appropriateness of growth stocks in retirement portfolios, they are not necessarily a good fit for every retired investor.  However, for those investors at or near retirement that are interested in adding some growth, I offer the following three Pharma growth stock opportunities that I am personally researching.  Most importantly, my initial review indicates that each of these candidates are reasonably valued based on their respective future growth opportunities.

Three Fabulous Pharma Growth Stocks

Two of the following three Pharma growth stocks were originally previewed in my previous article.  In this article I have added a third Pharma research candidate in what follows is my reasoning as to why I consider these attractive growth opportunities based on my preliminary research.  Perhaps readers of this article that have more information or familiarity with any of these companies will help the rest of us by sharing their knowledge.

To get a free more detailed perspective on these three Pharma stocks, follow this direct link to a video on my site mistervaluation.com and watch and listen to me analyze these companies out loud via the FAST Graphs fundamentals analyzer software tool.

Actavis plc (ACT)

Actavis, my first research candidate, is well-positioned to serve the growing pharmaceutical needs of our aging population.  The company offers both branded and generic pharmaceuticals worldwide.

Short business description courtesy of S&P Capital IQ:

“Actavis plc, a specialty pharmaceutical company, develops, manufactures, markets, and distributes generic, branded generic, branded, biosimilar, and over-the-counter (OTC) pharmaceutical products. It operates in three segments: North American Brands, North American Generics and International, and Anda Distribution.

The North American Brands segment provides patented and off-patent trademarked pharmaceutical products primarily under the Dalvance, Bystolic, Canasa, Carafate, Daliresp, Fetzima, Linzess, Namenda, Namenda XR, Saphris, Teflaro, Viibryd, Actonel, Asacol HD, Atelvia, Delzicol, Doryx, Estrace Cream, Enablex, Lo Loestrin Fe, and Minastrin 24 Fe brands.

The North American Generics and International segment develops, manufactures, and sells generic, branded generic, and OTC pharmaceutical products.

The Anda Distribution segment distributes generic and brand pharmaceutical products primarily to independent pharmacies, pharmacy chains and buying groups, and physician’s offices.

The company also develops and out-licenses generic pharmaceutical products primarily in Europe through its third-party business; and provides products in women’s health, gastroenterology, urology, and dermatology areas.

The company sells its generic and brand pharmaceutical products primarily to drug wholesalers, retailers, and distributors, including national retail drug and food store chains, hospitals, clinics, mail order retailers, government agencies, and managed healthcare providers.

It has a collaboration agreements with Amgen, Inc. to develop and commercialize biosimilar versions of Herceptin, Avastin, Rituxan/Mab Thera, and Erbitux; Ironwood Pharmaceuticals to develop and commercialize Linzessfor the treatment of irritable bowel syndrome with constipation and chronic idiopathic constipation; Sanofi-Aventis U.S. LLC; and Trevena for the development of TRV027. Actavis plc was founded in 1983 and is headquartered in Parsippany, New Jersey.”

Both demographics and acquisitions have stimulated accelerating earnings growth since 2011.  Nevertheless, Actavis trades at P/E ratio that is less than its historical earnings growth achievement.  However, the normal P/E ratio has moderately expanded as a result of extraordinary growth in 2013 and 2014.

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Importantly, Actavis has also generated cash flow growth that is aligned with its historical earnings growth.  Consequently, the company has ample resources to continue funding research and development and its reasonable 36% debt-to-capital ratio is well covered.

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Growth in earnings and cash flow since 2010 has resulted in significant total returns for Actavis shareholders.  Returns have significantly out-performed the general market, which is extraordinary when you consider that this timeframe has produced one of the best returns for the S&P 500 in recent history.  The stock market has nothing to do with the results that Actavis achieved.

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Looking to the near to intermediate time future, leading analysts continue to expect earnings growth in excess of 20% per annum for this fiscal year and next.  The company’s current P/E ratio is in alignment with this near-term forecast growth.  Consequently, the company offers double-digit return potential over the next couple of years.

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The following analyst scorecard summarizes analysts’ accuracy when making earnings forecasts one year and two year forward.  This provides additional confidence that Actavis might meet earnings forecasts for the next two years.

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Analysts also provide 3-5 year earnings estimates.  The consensus of 9 analysts expects long-term (3-5 years) earnings growth to average slightly less than 15% per annum.  This lower long-term forecast offers a potential negative to this company’s ability to generate double-digit returns longer term.  Although this is still a high earnings growth rate, the company’s current P/E ratio would indicate higher-than-optimum current valuation over the longer term.

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The following slides provide additional insight into the growth opportunities for Actavis.  For a more comprehensive review of the full presentation, follow this link.

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Valeant Pharmaceuticals International (VRX)

Valeant Pharmaceuticals is also well-positioned to serve the growing pharmaceutical needs of our aging population.  However, this candidate offers additional diversification due to the specific markets that it serves.

Short business description courtesy of S&P Capital IQ:

“Valeant Pharmaceuticals International, Inc. develops, manufactures, and markets pharmaceuticals, over-the-counter products, and medical devices worldwide.

The company offers Solodyn to treat red and pus-filled pimples of acne in patients, as well as Ziana, Acanya, Atralin, Retin- A Micro, and ONEXTON gel; Wellbutrin XL for major depressive disorder in adults; Jublia for onychomycosis of the toenails; Xenazine for chorea; Targretin for Cutaneous T-Cell Lymphoma; Arestin, a subgingival sustained-release antibiotic; and PROVENGE for the treatment of prostate cancer. It also provides Zovirax, an antiviral for recurrent herpes labialis and initial genital herpes; Syprine to treat patients with Wilson’s disease; Elidel to treat atopic dermatitis; Prolensa for inflammation and pain following cataract surgery; Duromine, a weight loss drug; and Lotemax gel for post-operative inflammation and pain.

In addition, the company offers PreserVision, an antioxidant eye vitamin and mineral supplement; CeraVe to rebuild and repair the skin barrier; ReNu Multiplus to lubricate and rewet soft contact lenses; Biotrue for healthy contact lens wear; Ocuvite, a lutein eye vitamin and mineral supplement; cleansing solution for gas permeable contact lenses; Artelac to treat dry eyes; AntiGrippin for acute respiratory and respiratory viral diseases, and influenza; and Bedoyecta, a vitamin B complex product.

Further, it provides SofLens daily disposable contact lenses; PureVision, a contact lens; various ophthalmic surgical products; Biotrue ONEday lens; medical device systems for aesthetic applications; and Bausch + Lomb Ultra, a contact lens.

Additionally, the company offers Tobramycin and Dexamethasone ophthalmic suspension for steroid responsive inflammatory ocular conditions; Cardizem CD to treat hypertension and angina; and Latanoprost for the treatment of glaucoma. Valeant Pharmaceuticals International, Inc. was founded in 1983 and is headquartered in Laval, Canada.”

Valeant Pharmaceuticals represents a second example of accelerating earnings growth since 2010.  Even though the company has experienced P/E ratio expansion thus far in 2015, I believe the company is still soundly-valued based on earnings potential.

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The biggest negative I find with this candidate is its high debt-to-capital ratio of 79%.  However, accelerating cash flow generation supports the company’s ability to service the debt, and as we will see with the follow-up slide presentation, the company is committed to reducing its debt moving forward.

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Once again we see an example of extraordinary historical performance as a result of strong operating results.  The total return potential from investing in growth stocks is powerful and significant, and not related to general stock market returns.

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On a short-to-intermediate-term basis, Valeant may be moderately overvalued.  However, thanks to the power of compounding, the company still offers the potential for total returns exceeding 20% per annum out to 2017.

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Once again the analyst scorecard summary indicates a high success rate for analyst forecasts made one year and two years prior to actuals.  Consequently, this provides some evidence that current forecasts may be reasonable and accurate.

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In contrast to what we saw with Actavis, long-term (3-5 year) analyst forecasts are strong at over 20% per annum on average.  Consequently, from a long-term total return perspective, Valeant may be the strongest choice.  However, that higher future return is somewhat less appealing based on the company’s current debt load.

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The following slides summarize the opportunity in front of Valeant.  Note the discussions on cash flows and the balance sheet on the last slide.  For a more comprehensive review of the full presentation, follow this link.

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Celgene Corporation (CELG)

Although my final candidate, Celgene, has the lowest historical growth since 2010 of the three, it has also had the most consistent double-digit growth over a longer period of time.  Consequently, although recent performance has been moderately lower than my first two examples, this is my favorite candidate of the three.

Short business description courtesy of S&P Capital IQ:

“Celgene Corporation, a biopharmaceutical company, discovers, develops, and commercializes therapies to treat cancer and inflammatory diseases in the United States and Internationally.

It markets REVLIMID, an oral immunomodulatory drug for multiple myeloma, myelodysplastic syndromes (MDS), and mantle cell lymphoma; ABRAXANE, a solvent-free chemotherapy product to treat breast, non-small cell lung, pancreatic, and gastric cancers; POMALYST/IMNOVID for the treatment of multiple myeloma; and VIDAZA, a pyrimidine nucleoside analog to treat intermediate-2 and high-risk MDS, and chronic myelomonocytic leukemia, as well as acute myeloid leukemia (AML).

The company’s products also include THALOMID for the patients with multiple myeloma and for the treatment of cutaneous manifestations of erythema nodosum leprosum; OTEZLA for psoriatic arthritis, psoriasis, and ankylosing spondylitis; ISTODAX to treat cutaneous and peripheral T-cell lymphoma; and FOCALIN, FOCALIN XR, and RITALIN LA products.

Its clinical stage products comprise oral anti-inflammatory agents targeting PDE4, an intracellular enzyme that modulates the production of multiple pro-inflammatory and anti-inflammatory mediators; CC-122 and CC-220 to treat hematological and solid tumor cancers, and inflammation and immunology diseases; cellular therapies, such as PDA-001 and PDA-002 for Crohn’s and peripheral arterial diseases; CC-486 to treat MDS, AML, and solid tumors; Sotatercept and luspatercept for the treatment of anemia; and CC-223 and CC-115 for lymphomas, hepatocellular, and prostate cancers.

The company has collaborative agreements with Novartis Pharma AG; Acceleron Pharma; Agios Pharmaceuticals, Inc.; Epizyme Inc.; Sutro Biopharma, Inc.; bluebird bio, Inc.; FORMA Therapeutics Holdings, LLC; MorphoSys AG; Acetylon Pharmaceuticals, Inc.; OncoMed Pharmaceuticals, Inc.; and NantBioScience, Inc. Celgene Corporation was founded in 1980 and is headquartered in Summit, New Jersey.”

As previously mentioned, I favor the consistent growth that this company has historically achieved.  But more importantly, and as we shall soon see, expectations are for future growth to continue at or above its historical achievements.

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Celgene’s debt-to-capital ratio is reasonable at 46% and supported by strong and accelerating cash flow growth.

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Although historical performance since 2010 has been lower than my first two candidates, it is still extraordinary when compared to the average company.

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Since we cannot invest in the past, only the future, the future growth expectations of Celgene are the primary reason I favor it over the other two candidates.  Importantly, it appears that Celgene is soundly-valued based on earnings growth estimates exceeding 25% over the next two years.

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The one year forward and two year forward analyst scorecard for Celgene is also encouraging.   The company has met or exceeded analyst estimates over 70% of the time.

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Regarding longer-term 3-5 year growth, Celgene is expected to grow faster than the previous candidates.  Given this company’s consistent historical record, I believe the potential for total annualized returns exceeding 20% are well-defined.

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The following slides illustrate the important and large opportunities that Celgene serves.  For a more comprehensive review of the full presentation, follow this link.

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Summary and Conclusions

The three Pharma companies presented in this article offer intriguing potential for above-average future long-term earnings growth.  Importantly, based on that earnings growth potential, each of them appear soundly valued at current levels.  However and perhaps most importantly, their growth potential is, for the most part, independent of the overall economy.  Each of these companies possess unique characteristics supported by the powerful demographic trend of an aging population.

Consequently, I believe it’s worth putting concerns about the market or economy aside, and focusing instead on the opportunities that each of these big Pharma growth stocks offer.  Finally, I remind the reader that I have not personally completed my research and due diligence.  Therefore, I suggest that further comprehensive research and due diligence should be conducted.  On the other hand, the long-term total return potential of each of these candidates seems worthy of that effort.

Disclosure:  No position at the time of writing.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.