My favorite piece of investing wisdom is “be fearful when others are greedy, be greedy when others are fearful.” On Trump’s inauguration day, there is no industry wherein investors are more fearful than the pharmaceuticals industry.
And justifiably so. It’s important to realize that investors hate uncertainty even more than bad news. Donald Trump made countless controversial statements and promises throughout his campaign, and he continually changes his stance on several topics, most radically, healthcare. In the early GOP debates we heard a candidate who wanted to entirely repeal the Affordable Care Act, and replace it with “something great.” Following the election, President Trump acknowledged that there are many aspects of the Affordable Care Act that he would retain, such as coverage for individuals with pre-existing conditions. This has been a theme with President Trump – early signs suggest that he will not take the extremes that his campaign may have suggested regarding a number of political topics.
I will not try to predict what the Trump administration will do with the future of American healthcare – because nobody truly knows (arguably Trump himself). As a result, the pharmaceutical industry has prepared for the worst, given its substantive drop since Trump’s electoral victory. Pessimism regarding the future of healthcare in America is solidly built into companies’ stock prices, thus presenting a buying opportunity. Pharmaceutical companies are trading at an attractive value if you believe that the fundamentals of healthcare are solid.
My pick is Teva Pharmaceuticals. There are a few aspects of this company that mitigate its exposure to risk that is traditionally associated with volatile pharma companies. First and foremost, it is a $35 billion company and is firmly established as one of the largest companies in the global generic pharma industry. It is planning to release almost 1,000 drugs in 2017, and maintains a substantive marketshare, thus it does not live or die by one product. A P/E of 20 (industry average of 29) and P/B of 1.2 (industry average of 6.0) suggests the Israeli pharma titan is not overvalued. A dividend of 4% provides additional cash flow and some reassurance.
But Teva dropped nearly 50% in 2016… why is there good value in Teva?
The company had an overwhelmingly disappointing 2016 for a number of reasons. First and foremost, general fears about the future of the pharma industry as described above have weighed each and every pharma company. But the real killer for Teva has been the future of its top revenue-generating drug, Copaxone, and thus lower EPS estimates for 2017. This drug accounts for 20% of Teva’s revenue stream, and three of its patents have been under review since Q2 ’16. As a result, investors assume that the drug will be subject to generic competition, weighing the shares even further. If the patent board determines that such patents are not valid in Q1 ’17, the stock may slip, but not significantly, given this is the expected result. If such patents are confirmed, Teva shareholders will be rewarded tremendously.
All pessimism regarding the pharma industry and Copaxone is already built into a cheap $33 price tag for a share of Teva. My view is the market has simply overreacted in its Teva selloff, and the fundamentals of this established pharma company will weather the current storm and emerge very strong. A Q4 earnings call revealed lower guidance for 2017, and revenue goals that the company should reach even in unfavorable conditions.
This is a medium risk investment. While I believe the pharma industry will continue its long-term prosperity, the future actions of President Trump’s administration are truly unknown, and thus so is the behavior of stocks in that sector. This would be a long-term investment; shareholders need to exhibit patience in the 18-24 month range to realize substantive gains.
Goldman, Deutsche, JPMorgan, Guggenheim, Credit Suisse, Wells Fargo, Oppenheimer, Morningstar, and S&P Capital have BUY ratings on the stock. The one commonality across analysts is pessimism is fully built into the stock, considering Copaxone uncertainty and lower growth expectations. Can the falling knife get much lower? I think not.
PLEASE NOTE: EDWARD C. MCCANN DOES NOT BEAR ANY RESPONSIBILITY OR LIABILITY WITH RESPECT TO RESEARCH MADE AVAILABLE. INVESTORS SHOULD UNDERSTAND THAT THEY ASSUME FULL RESPONSIBILITY FOR ANY TRADING DECISIONS THEY MAKE BASED UPON THIRD-PARTY RATINGS OR REPORTS.
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