Inside Wall Street: How Goldman Is Playing the Coming Tide of Generic Drugs

Gene Marcial's Inside Wall StreetGeneric drugs are expected to enjoy a banner year in 2011, prompting some investment pros to reformulate their portfolios to get a jump on the transition.

Viewing the medical industry's enormous drug supply chain, some Wall Street strategists are betting on several wholesale distributors and retail drugstores they believe will get a big advantage from the shift to generics from brand-name drugs.

With over $20 billion worth of brand drugs losing protection starting this year, "generics and specialty [drug] launches will make 2011 an attractive year," says a Goldman Sachs team of analysts led by Matthew J. Fassler. The analysts believe three drug "supply chain" distributors are attractive investments in the current environment.

"We prefer exposure to those linked to hospital and physician use," he says. Generics, he adds, are a common theme in Goldman's coverage in the drug-distribution industry. The other analysts in the Goldman group are Robert P. James, Randall Stanicky and Verdell Walker. They expect the diversified large distributors, in particular, to benefit from several exclusive launches of generic drugs in 2011.

"Best Leverage to Generics

"We are buyers of Amerisource Bergen (ABC), McKesson (MCK) and Medco (MHS)," says Fassler, who notes that generic launches typically have sparked margin expansion at these large distributors. "We expect this to continue in 2011, given several exclusive launch scenarios," he says.

Among the retail drugstores, Goldman analysts favor Walgreen (WAG), where a focus on existing assets, they argue, is yielding margin improvement and expense control, and CVS Caremark (CVS), which is the retailer that's most leveraged to generics.

Amerisource, whose stock has leaped from a 52-week low of 27 a share on Aug. 31, 2010, to $37 on March 1, is Goldman's favorite distributor, because "its exposure to the independent pharmacy customer gives it the best leverage to generics," according to Fassel. Also, he expects its specialty distribution business to gain from some key specialty generics, including Eloxatin, Gemzar and Taxotere.

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Eloxatin, a treatment for colorectal cancer, was the biggest single specialty generic launch in 2010, which contributed 25 cents, or 11%, a share to Amerisource's 2010 earnings. The six companies that produced the generic drug came to an agreement last year with the branded medicine's manufacturer, Sanofi Aventis (SNY), to suspend further production of the drug but to restart making them in August of 2012.

Gemzar, a generic for various cancers, including breast and lung, generating sales of $800 million a year, was launched Nov. 15, 2010. The branded drug is produced by Eli Lilly (LLY). Gemzar sales will be a big boost to Amerisource this year, the analysts say.

Taxotere, a generic drug for breast and prostate cancer, "will be the biggest near-term catalyst for distributors such as Amerisource." The generic, whose branded sales were roughly $1.2 billion a year, could get approval soon, says Fassel. And if approved, the most noticeable impact will be to Amerisource, followed by McKesson, given their 55% and 25% market shares, respectively, in the specialty distribution market," the analyst says.

Enter Generic Lipitor

Among other generics that are scheduled to come to market this year is the one that will replace Pfizer's blockbuster Lipitor, the largest-selling branded drug in the world, with annual sales of $7.2 billion. The maker of the generic version of Lipitor, Ranbaxy Labs, will release the product by November this year. Watson Pharmaceutical is also scheduled to come out with its own generic Lipitor. Medco has disclosed an expected significant impact on its bottom and top lines in December from the generic Lipitor.

Also among other generic versions coming on stream are Concerta, a treatment for ADHD (attention deficit hyperactivity disorder) developed by Watson, scheduled for release on May 1, 2011, whose branded drug generated yearly sales of $1.4 billion; Lotrel, a generic drug for high blood pressure, with branded annual sales of $360 million; and Rythmol, a generic drug to treat irregular heartbeat, whose branded version took in annual sales of $121 million.

Goldman values Amerisource's stock, currently trading at $37 a share, at $42 in 12 months. McKesson, now selling for $79 a share, is worth $84, according to Goldman, which started recommending the stock when it was trading at $72 in late January. Medco, now trading at $62, is up from a 52-week low of $43 in late August 2010. Goldman's 12-month target is $77 a share.

Outside the Health Care Battles

Among the retail drugstore chains, Walgreen and CVS are engaged in extensive store remodeling or repositioning efforts to enhance returns. They're also buying back shares and are likely to hike their dividends, says Goldman's Fassel. Walgreen, whose stock is now trading at $43 a share, is up from its 52-week low of $26 hit in July 2010. Goldman's 12-month target is $46. CVS, now trading at $33 a share after hitting a 52-week high of $37.85 on Apr. 15, 2010, is worth $42, according to Goldman.

In all, the drug distribution and retailing sectors, which didn't get embroiled in the heated battles over the health care reform, are surely attractive investment bets as consumer spending for essential medical needs rises quickly.

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