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Generic-Drugs Outlook: Price Erosion to Hurt Near-Term Prospects

Zacks Equity Research

The Medical - Generic Drugs industry comprises companies, which develop and market chemically/biologically identical version of a brand-name drug once patents providing exclusivity to the branded drugs expire. These drugs can be differentiated into two categories – generic and biosimilar – based on their composition. The generic drugs are developed and marketed by large pharma companies as well as several smaller companies.

The generic segment is controlled by a few large generic drugmakers and generic units of large pharma companies. Several smaller companies also develop generic version of branded drugs. Generic/biosimilar drugs are significantly cheaper than the original drug.

However, competition in this segment is higher, which results in thin margins for the manufacturing companies. A few companies in this industry also have some branded drugs in their portfolio, which helps them tap a higher-margin market.

Let’s take a look at the industry’s three major themes:

  • The generic drug industry faces headwinds like competitive and pricing pressure, which is negatively impacting the top line of generic drug makers. Moreover, the ongoing consolidation of customers in the generics industry results in increasing price erosion.  It has increased the ability to negotiate lower prices for generic drugs. Patent litigations also drive expenses higher. However, a top-player expects the generic industry to stabilize in 2019.
     
  • The generic drug companies depend on the loss of patent exclusivity for branded drugs and may have to face litigations to market the generic version of these drugs. A company may launch an authorized generic, giving them exclusivity of several months over other generic versions of the same drug. Although development of biosimilars is complex, a few companies have already forayed into the segment.
     
  • Generic drugs increase competition in the market as they bring down prices significantly and are easily accessible to a wider patient population. Several branded drugs have sales running into billions of dollars. Although generics have thin margins, their high sales volumes help generic drugmakers reap profits. Meanwhile, the government is focusing on raising competition in the pharma space with faster approval to generic/biosimilars. This boosts the prospects of these companies as many blockbusters drugs are set to lose patent protection over the coming years.

Stabilization of the generics market in the United States can work in favor of generic drug makers. Moreover, several blockbuster drugs are set to lose patent protection going forward, thus boosting prospects of generics.

Zacks Industry Rank Indicates Gloomy Prospects

The Zacks Medical – Generic Drugs industry is housed within the broader Zacks Medical sector. It carries a Zacks Industry Rank #155, which places it in the bottom 40% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bleak near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are losing confidence in this group’s earnings growth potential. In the past year, the industry’s earnings estimate for 2019 and 2020 has declined almost 13% and 15%, respectively.

Our proprietary Heat Map shows that the industry’s rank has deteriorated over the past four weeks.

Heat Map

We will present a few stocks that are well positioned to outperform the market based on a strong earnings outlook but it’s worth taking a look at the industry’s shareholder returns and current valuation first.

Industry Lags on Stock Market Performance

The Zacks Medical – Generic Drugs Industry has lagged the broader Zacks Medical Sector as well as the S&P 500 Index over the past year.

The industry has declined 18% over this period compared with the broader sector’s fall of 1.2%. However, S&P 500 Index has risen 1.7% in the said time frame.

One-Year Price Performance

 

Industry’s Current Valuation

On the basis of trailing twelve months price-to-sales ratio (P/S TTM), which is a commonly used multiple for valuing generic companies, the industry is currently trading at 1.46 compared with the S&P 500’s 3.34 and the Zacks Medical sector's 2.97.

Over the last five years, the industry has traded as high as 5.26X, as low as 1.30X, and at the median of 2.86X, as the chart below shows.

Price-to-Sales Trailing Twelve Months (TTM) Ratio

 

 

Bottom Line

The competition in the generic market is intensifying as the market is already crowded and faster approval by the FDA will bring more drugs into the market. The first company to launch a generic version once a brand product loses exclusivity is likely to capture significant market share. Hence, the companies with strong pipeline of generic drugs and a large portfolio of abbreviated new drug applications (ANDAs) are likely to reap profits.

Meanwhile, some companies have huge debt burden, which may compel them to avoid prudent acquisitions and strategic deals. Moreover, pipeline or regulatory setbacks will delay generic launches, which may be a severe blow to companies’ prospects.

In the Generic Drugs universe, no stock currently sports a Zacks Rank #1 (Strong Buy), while three companies have a Zacks Rank #2 (Buy). Most of these companies have witnessed positive earnings estimate revisions in the past 60 days.

You can see the complete list of today’s Zacks #1 Rank stocks here.

Mallinckrodt (MNK): This Ireland-based drugmaker has seen 29.9% rise in its share price in the past year.  The Zacks Consensus Estimate for this #2 Ranked stock's EPS for 2019 has been revised 1.8% upward over the past 60 days.

Price and Consensus: MNK

Assembly Biosciences, Inc. (ASMB): The Zacks Consensus Estimate for this Carmel, IN-baseddrugmaker’s loss per share for 2019 has narrowed 1.4% over the past 60 days. Assembly Biosciences has a Zacks Rank #2. However, the stock has declined 59.8% in the past year.

Price and Consensus: ASMB

 

Sol-Gel Technologies Ltd. (SLGL): The Zacks Consensus Estimate for this Israel-based drugmaker’s loss per share for 2019 has narrowed almost 1% over the past 60 days. This Zacks Rank #2 company’s stock has declined 40.7% in the past year.

Price and Consensus: SLGL

 

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