Insiders Adopt an Orphaned Drug Stock

A curious trend has developed in the pharmaceutical industry over the past decade. Major drug firms are abandoning products that don't hold blockbuster potential. Apparently, the marketing and sales spending on smaller drugs just isn't worth it.

As a result, a cottage industry has emerged to pick up the smaller "orphaned drugs" and sell them through lower-cost sales channels. Investors have come to know this industry thanks to the meteoric rise of King Pharmaceuticals(KG). With an $8.6 billion market cap, King has come to symbolize just how profitable it can be to pursue these discarded drugs. Other firms such as First Horizon Pharmaceuticals(FHRX), Forest Labs(FRX) and Medicis Pharmaceutical(MRX) have also come to garner rich multiples, thanks to investor appreciation of these high-margin businesses.

Only Bradley Pharmaceuticals(BPRX) can still be considered inexpensive in this orphan drug sector.

Bradley emerged from obscurity in 2001. Before then, the company's stock languished in the $2-$3 range for many years. But a management decision to exit a number of medical markets and focus strictly on dermatology and gastroenterology products yielded phenomenal results. Sales and profits have skyrocketed over the last six quarters, taking the stock all the way up to $22 in early February.

But after the company reported in-line fourth-quarter 2001 results, momentum investors exited Bradley Pharmaceuticals, sending it all the way back to $12. At its present price, Bradley trades for just 21.5 times the median of management's 2002 EPS guidance of 55 cents to 58 cents. This may be in line with Bradley's percentage return on equity, but it is low for a company that is expected to increase its bottom line by over 50% for a second straight year. One analyst expects that growth to continue after this year as well, and has posted an EPS estimate of 88 cents for 2003.

A Relative Bargain

Bradley Pharmaceuticals looks particularly underappreciated compared to its above-mentioned peers. Of the group, only Forest Labs is expecting growth similar to that of Bradley's this year, and its stock is trading for 53.5 times expected earnings. Even Medicis, with expectations of only 18.3% bottom-line growth this year, is fetching a forward multiple of 27. And while the other specialty pharmaceutical stocks trade for an average of 15 times annualized trailing revenue, Bradley trades for just five times its figure.

This might be understandable if Bradley's financial condition was iffy, but the company has virtually no debt, a decent amount of cash on hand and increasing cash flow. The biggest difference between Bradley Pharmaceuticals and its peers seems to be that it is the smallest of the bunch and has much less Wall Street coverage. With a market cap of only $123 million, large institutions can't make enough money buying in. Trading volume is well above 300,000 shares a day, though, so individuals and smaller fund managers don't have to fear a lack of liquidity if they take advantage of this bargain.

Bradley Pharmaceuticals' recent selloff is also a surprise considering that the fourth-quarter results weren't all that bad. A management decision to reorganize and expand the sales staff in line with its two distinct market niches caused expenses to tick up. But that process is now largely complete, and rising sales should provide a great deal of operating leverage.

Equally important, Bradley's most popular drugs are taking market share away from competitors at a steady rate. And management, thanks to a follow-on equity offering completed last fall, hopes to acquire additional drugs this year to push through its sales channels.

Insider Support

Eight insiders, several of whom recently took profits when shares traded in the upper teens, acknowledged the selloff by acquiring more than $107,000 in stock when it dipped below $13. This is not the strongest insider signal we've seen, but it was interesting enough to get us to research Bradley's fundamentals -- and we liked what we saw.

The group's purchase was coordinated, and the executives chose to buy the stock en masse with their bonus money. But CFO Brent Lenczycki says that insiders purchased the shares at open-market prices and were not given an extra incentive to buy the shares. Although insiders didn't have to take money out of their pockets for the purchases, they could have put their bonus money in their pockets instead.

We also note that several long-term insiders like Lenczycki didn't show the normal pattern of selling during their stock's meteoric 900% rise in 2001. Instead of taking profits, many even averaged up. Many insiders obviously believe the company line that Bradley is on target to continue the recent performance of meeting or exceeding estimates.

Looking for another catalyst? Larger players such as King are growing through acquisitions, and recent transactions have been priced at high levels. For example, King acquired Jones Pharmaceutical last year for 13 times annualized trailing revenue. Again, that's almost three times Bradley's current multiple. And Bradley's revenue run rate is expected to keep on rising throughout 2002, so the price tag may only increase.

Bradley Pharmaceuticals recent volatility is the biggest negative I see, and there is a risk that the stock has not yet hit bottom yet. But I feel this is a fundamentally strong enough firm to take that risk on by entering now.

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