This is a great era to be making generic drugs. With Wal-Mart selling them for $4 and insurance formularies increasingly favoring generics, this segment of the pharmaceutical world is on the upswing at a time when big, research-based drug companies are having trouble developing new blockbusters.
About 67% of the U.S.'s prescription volume is now generics, according to IMS Health. This puts generic-drug giants, such as Mylan Laboratories (symbol MYL), in an enviable position.
Mylan is doing its best to take advantage of this favorable environment. It has always had a formidable business in the U.S., run from Canonsburg, Pa. But it recently bought the generic-drug business of Germany's Merck KgaA (not to be confused with Merck in the U.S.), making Mylan a player in Europe and the third-biggest generic-drug company worldwide. An agreement with Famy Care of India to manufacture a slew of generic oral contraceptives and the purchase of Matrix, an Indian generics maker, gives Mylan access to lower labor costs in that country.
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But Mylan's growth spurt came at a price. Nearly debt-free as recently as 2006, the company now owes almost $5 billion -- this at a time when credit markets around the world are cranky, to say the least. "That's one of the risks of the stock," notes analyst Martha Freitag of Argus Research. "This is a riskier investment idea than a company that has a conservative balance sheet." Most of Mylan's financing is in place, however.
Freitag upgraded the stock from "hold" to "buy" on September 30 on the strength of Mylan's product launches and its slim valuation -- the stock closed at $10.27 on October 3, down more than 60% from a year ago.
The debt load forced Mylan to suspend its dividend and dilute shareholder value by issuing an additional $3 billion in equity financing last year.
Mylan had hoped to sell Dey, its specialty-pharmaceutical division. But the business didn't fetch the price that Mylan was seeking, so Dey is off the sale block. The firm planned to use the proceeds from that sale to pay down debt. "The Dey transaction would have made me much more comfortable with the debt level," says Morningstar analyst Brian Laegeler, who thinks that Mylan should sell Dey for whatever price it can in order to make headway on the debt.
Yet Laegeler thinks the acquisitions ultimately put Mylan on the right path. "What people are missing is the large amount of cost saving that is going to come through in the next three to five years," he says. "And that's going to help them pay off the debt."
Mylan can increase sales and ultimately earnings through various channels. The firm recently launched several new products, including Johnson & Johnson's Alzheimer's and antipsychotic medications, Razadyne and Risperdal, respectively.
In 2011, a number of blockbuster drugs held by the big pharmaceutical companies come off patent, including Pfizer's Lipitor, a cholesterol-lowering drug, and Plavix, a medication for blood clots. Generic biologics, which are still five years away from market debut, would give Mylan yet another avenue. And both presidential candidates vow to make generic drugs a big piece of their health-care reform plans as a way to contain costs.
And then there's that attractive valuation. On average, analysts expect the company to earn 99 cents a share in 2009 -- double the anticipated 2008 earnings of 50 cents. That puts its price-earnings ratio for this year's profits at a reasonable 20 and for next year's at a very tempting 11, which is one of the lowest among the general drug clan. "At this valuation," says Argus's Freitag, "the risks are fairly well recognized."
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