Forest Laboratories ( FRX) is the second-worst performer in the Amex Pharmaceutical Index (DRG) year to date, down 24% at Wednesday's closing price of $38.40 (up $1.20). One reason for the poor performance is a problem that affects most drugmakers -- investors are worried about the lack of potential blockbuster drugs in the company's clinical pipeline. But Forest has now received two analyst upgrades this week, focusing on the stock's discount valuation. At current levels, the shares are trading at just 12.3 times expected fiscal 2008 (ending March) earnings of $3.12 per share. That represents a 14% discount to the company's historical average valuation, and is also below the mid- to high-teens earnings
multiples that competitors Merck ( MRK), Eli Lilly ( LLY) and Abbott Laboratories ( ABT) command. With that in mind, I'm here to answer readers' questions: Should you buy shares in Forest Laboratories? Does Forest Labs hold value at these prices, or is the stock bad medicine? On Sept. 5, Forest won a key court appeal, blocking Teva Pharmaceutical ( TEVA) from making a generic version of its antidepressant Lexapro until the patent expires in 2012. The drug generated some $2.1 billion of revenue last year, or more than 60% of the company's total sales. Forest's other key product is Alzheimer's treatment Namenda, which has patent protection until 2013, and also accounts for about 20% of total revenue. Namenda sales grew 27% year over year in the fiscal first quarter (ended June) to $191.7 million, and is also expected to reach $1 billion of annual revenue by 2010. To watch David Peltier's video take of this column, click here .
In comparison, few of the products in the company's clinical pipeline have the potential to become similar blockbusters. One of the most promising in trials is milnacipran, a fibromyalgia treatment that is expected to be submitted to the Food and Drug Administration for approval by the end of the year and could one day reach $1 billion a year in revenue. But most of Forest's clinical pipeline contains products like hypertension drug nebivolol. The FDA is expected to rule on the product in November, but that drug is projected to peak out at just $200 million of annual revenue. In the meantime, Forest has a strong balance sheet with $2.3 billion ($7.25 a share) of cash and investments, compared with no debt. In August, management pledged some of this money to buy back up to 35 million shares, or 11.1% of the company, over time. In addition, Forest can use its cash hoard and solid operating cash flow ($900 million over the past four quarters) to acquire more potential drugs for its pipeline. All in all, I do believe that Forest Labs is attractive to purchase at current levels. The shares will likely not trade back up toward the 2004 high price of $78.81 anytime soon, though the current discount valuation does not give the company credit for the recently affirmed patent protection of its top-selling drugs. Additionally, management has a lot of cash at its disposal to repurchase shares and consider acquisitions to bolster its sparse clinical pipeline. I believe that Forest can reach $45 a share over the next year, representing a 17% gain from current levels.