4 Drug Stocks Poised to Stage Comeback

NEW YORK (TheStreet) -- Health-care stocks, especially drug shares, performed downright sickly in 2010. That could change this year, as some fund managers say overlooked and undervalued companies may finally provide healthy returns.

The Healthcare SPDR ETF ( XLV) rose barely 1% in 2010, compared with a 13% jump in the S&P 500 Index. The largest holdings of the Healthcare SPDR are Johnson & Johnson ( JNJ) (13.5%), Pfizer ( PFE) (11.5%) and Merck ( MRK) (9%). They all finished in the red last year, helping to make health care the worst-performing sector in the S&P 500.

Russell Croft, manager of the Croft Value Fund ( CLVFX), says some drug stocks provide stability because they're cheap, pay big dividends and have strong balance sheets. A catalyst, he says, are companies benefiting from emerging markets, where a growing middle class is able to pay for drug therapies.

Bob Auer of the Auer Growth Fund ( AUERX) says some mid-cap or second-tier pharma stocks can easily get a boost by a "new product or something exciting can move the needle."

TheStreet searched for 2011's most dynamic drug stocks with Auer and Croft.

Johnson & Johnson ( JNJ)

Johnson & Johnson is a diversified manufacturer of health-care products including pharmaceuticals, consumer products and medical devices. Due to their vast product portfolio, huge scale and the defensive nature of the industry, J&J is a relatively stable investment in any economic environment, says Croft. Half of sales come from abroad, and they will benefit from faster-growth emerging markets over the next decade.

Croft also likes the company's AAA-rated balance sheet, which is one of the strongest across any industry, with $22 billion in cash and about $12 billion in debt. J&J is in the middle of an extensive cost-cutting program that consists of consolidating pharmaceutical operations, integrating the medical-device business and improving efficiency across the entire company, which should combine to yield up to $1.6 billion to the bottom line.

"Their pharmaceutical pipeline is one of the best in the group and new products could add an estimated $5 billion to segment sales by 2013. New products will contribute over $1.5 billion to segment sales this year from launches of Stelara, Simponi, Sustenna and Nucynta," says Croft.

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Cephalon ( CEPH)

Founded in 1987 as a biotech startup, Cephalon has emerged as one of the world's top 10 biopharmaceutical companies, with an impressive roster of first-in-class products, and total revenue of $2.19 billion in 2009. The company's portfolio includes treatments for central nervous system disorders, pain and cancer. Cephalon boasts eight proprietary products in the U.S., along with more than 100 products internationally.

The company's stock performance over the past 12 months, however, has been nothing to brag about, with its shares falling over 6%. Nevertheless, Auer expects that to change in the coming year.

"Cephalon's stock has been slightly down in the past year, yet the 2010 estimates by a consensus of 26 analysts has risen to $7.80 per share from $6.03 in 2009. Meanwhile, sales are expected to jump 26% to $2.77 billion and with a market cap of about $4.5 billion, this company is very digestible for one of the bigger players," says Auer.

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Momenta Pharmaceuticals ( MNTA)

Cambridge, Mass.-based Momenta is a biotechnology company with a product pipeline of both complex mixture generic and novel drugs. The company's M-Enoxaparin is designed to be a technology-enabled generic version of Lovenox, a low molecular weight heparin used to prevent and treat deep vein thrombosis. Momenta's second major generic product candidate is a generic version of Copaxone, a drug used to reduce the frequency of relapses in patients with Relapse-Remitting Multiple Sclerosis. On the horizon, Momenta's lead novel drug candidate has been engineered to support the treatment of acute coronary syndromes, or ACS.

Shares of the company spiked up to $26 a share last July on news of FDA approval for its generic anti-clotting drug, but retreated back to $15 by the end of the year over valuation worries. Auer says the company's pipeline, earnings growth and partnership with Sandoz will help propel the stock back near last summer's highs.

"Momenta has nearly 200 employees who have figured out a better way to make drugs that attack blood clots. Earnings and revenues rose drastically in 2010 at Momenta, and we are confident this will continue in 2011," says Auer.

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Merck ( MRK)

Merck's merger with Schering-Plough at the beginning of 2010 should help the company in multiple ways, says Croft, including adding significant assets to the pipeline, strengthening its international presence, enabling cost savings of roughly $3.5 billion annually by 2012 and, most importantly, diluting the effect of the patent cliff over the next few years to which the company was previously much more exposed. The pipeline seems under-appreciated in Croft's view, with a significant number of Phase III assets that boast large addressable market potential. The company has about 20 Phase III projects, 45% of which came from Schering-Plough.

As for valuation, Merck currently trades at 11 times 2010 earnings and less than 10 times forward earnings, with a 4.1% dividend yield. Croft expects the company to grow its earnings in the mid-to-high single digits with a lot of help from its emerging-market operations.

"Merck has the fifth-largest footprint in emerging markets of all pharmaceutical players, but still only 3% market share. And 20% of sales come from these markets currently, and the company expects this to grow to 25% by 2013," says Croft.

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>To see these stocks in action, visit the 4 Drug Stocks portfolio on Stockpickr.

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Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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