Jensen: A Pair of Healthy Generic Drug Makers

Overall prescription drug spending in the U.S. rose 1%, year over year, in May, its strongest month of growth of 2012. Generic drugs posted a much better growth rate of 5% offsetting the 16% decline in branded drugs. I like the generic drug sector at current valuations and have a couple in my portfolio. Generics have several long-term tailwinds in their favor:

A. The aging of the population in developed countries.

B. Huge new markets coming online in the emerging economies.

C. The constraints in Western government's budgets, providing a large incentive to move to generics paid for by government programs.

D. A significant amount of blockbuster branded drugs coming off patent over the next several years.

These secular trends have led Credit Suisse to project generics will account for 89% of all drug prescriptions in 2021 from 77% today. Here are two generic drug makers that look good right now based on valuation and long-term prospects.

Mylan (MYL) is a worldwide generic (91% of total revenues) and branded drug maker with a market cap of just over $9 billion.

Four reasons MYL delivers good value at $21 a share:

• The stock is selling at the bottom of its five-year valuation range based on P/B, P/E and P/CF.
• The company has pursued strategic acquisitions that have allowed it to increase revenues at an annual clip north of 22% over the past five years. It has several key products including an epinephrine auto-injector with more than 95% market share in the U.S. In addition, 30% of worldwide HIV patients use a Mylan product.
• Mylan has done a solid job of reducing the debt incurred for these acquisitions over the past few years and has grown its adjusted EBITDA at an average 17.5% yearly clip over the preceding four years.
• The company has exceeded earnings estimates each of the last four quarters and consensus earnings estimates for FY2012 and FY2013 have ticked up over the last two months. MYL sells for a forward PE of under 8, a significant discount to its five-year average (14.4).

Teva Pharmaceuticals (TEVA) is the largest generic drug maker in the world and is based in Israel.

Four reasons TEVA is a solid long-term value pick for patient investors at $38 a share:

• The company has been hit hard by worries about the expiration of its best-selling drug, Copaxone, as well as recently reduced guidance. However, as it is trading at just 6.5 forward earnings, the bad news appears fully priced into the stock.
• The company has a well-respected new CEO, who should serve as a long-term catalyst and change agent for the company and the stock. Easing of the situation in Iran also should reduce the "Israel" discount hanging over TEVA as well.
• The stock sells at the very bottom of its five-year valuation range based on P/E, P/S, P/CF and P/B. TEVA also yields 2.1%.
• The median analysts' price target is $51 a share for the 20 analysts who cover Teva Pharmaceuticals. The stock also appears to have technical support just under current price levels.

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