A novel way to play the approaching pharma patent cliff.
The pharmaceutical industry has had a torrid time of late. It has been a tale of diminishing returns despite countless billions spent on research, looming patent cliffs and thousands of jobs lost.
The latest business to suffer has been Swiss drug maker Novartis, which has cut 2,000 jobs in the US in anticipation of lower sales for two of its hypertension medicines.
A looming patent cliff
And there is more trouble to come for many pharmaceutical companies, as a large number of pharma patents are set to expire in 2012 and 2013. Plus many Big Pharma firms have relatively weak drug pipelines, and may find it difficult to replace their lost earnings. Some companies will suffer more than others, as I discussed in a recent article.
Clearly, the landscape of the pharmaceutical industry is changing. The overall drugs market is expanding, as increasing wealth and population in emerging markets leads to greater healthcare spending. But as more and more patents expire, and many governments become more cost-conscious, an increasing proportion of the market is being taken up by generics.
But generics are booming
So how do you play the approaching pharma patent cliff? Well, how about investing in the world's largest generics business?
Teva Pharmaceuticals (NASDAQ: TEVA.US) is the biggest generics manufacturer in the world. It is also one of the 15 largest pharmaceutical companies worldwide.
There are a select few firms that control the lion's share of global generics production. Teva is by far the biggest of these companies, with more than double the revenue of the next largest company.
Headquartered in Israel, Teva has facilities in Israel, Europe, North America and Latin America, and employs 40,000 people. It produces a broad range of generic drugs and it has a manufacturing infrastructure that no other generics company can match.
This means that as soon as a popular drug goes off patent, Teva can hit the ground running and rapidly produce a generic product of the same quality as the original product, but offered at a fraction of the price. Make no mistake, this is a professional outfit.
A rapid rate of growth
As the leading generics manufacturer, Teva has much to gain from the large number of patents set to expire in the next few years. The company has estimated that products with sales of $150 billion will lose patent protection between 2010 and 2015.
To take advantage of this, Teva has been expanding with the aim of grabbing as much of the generics market as possible, largely through some pretty substantial acquisitions.
In fact, the business has doubled its revenues to $16 billion in the five years to 2010. But that is not the end of the story. The 2010 annual report set a goal of doubling revenues again to $31 billion by 2015. It aims to do so by increasing market share in all the major world markets, increasing the number of generic drugs it produces, producing more branded products and pursuing suitable acquisitions.
That is a very ambitious goal, but even if it isn't reached, I do expect Teva to continue growing over the next few years.
Teva does have one major weakness and, ironically, it is in the area of patented drugs. It sells only two patented medicines, and one of these is Copaxone, which is the world's bestselling drug for the treatment of multiple sclerosis. But its patent expires in 2014. However, my view is the generics business is expanding fast enough to compensate for the loss of this drug.
Perhaps because of the Copaxone issue, Teva looks cheap for a growing company. At its current price of $45.83, it is on a trailing price-to-earnings (P/E) ratio of just 13.
A London-listed alternative
If you are looking for a UK-listed alternative to the Israeli firm, there is Hikma Pharmaceuticals (LSE: HIK), which is the largest generics producer in the Middle East and North Africa. It is a far smaller company, but it is growing even faster than Teva, having nearly tripled its revenue since going public in 2005, and I expect this growth to continue. However, Hikma is rather more expensive than Teva; at its current price of 733p, it is on a trailing P/E ratio of 21.
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