There is Life After Patent Expirations: Why Pfizer and Lilly Stocks Rebounded

There's an air of gloom around the big pharmaceutical companies: Major drugs have been falling over the "patent cliff" lately, leaving their makers without exclusive license to sell the compounds, and stiff competition from generics. More than a dozen blockbuster drugs are scheduled to go generic through the end of next year, threatening to decimate drug-maker profits in the process.

But the recent experience of Pfizer (PFE) and Eli Lilly (LLY) suggests investors might look ahead to a post-generic stock bounce from in least some of these stocks.

Pfizer and Lilly lost big name-brand drugs to generic competitors a little over a year ago. Both have seen their stocks rise sharply since. In November last year, Pfizer lost patent protection for cholesterol-fighting cash cow Lipitor -- revenue from the drug plunged to $749 million in the third quarter, from $2.6 billion in the same quarter of 2011. Since then, however, Pfizer's shares have soared nearly 35%.

For Lilly, the day of reckoning was Oct. 25, 2011, when competitors announced a generic version of Zyprexa, an antipsychotic medication. The drug brought Lilly just $375 million in revenue last quarter, down from $1.2 billion in third-quarter 2011. But Lily's shares have risen more than 30% since then.

PFE Chart

PFE data by YCharts

With advance warning, of course, the stocks tend to trade down in anticipation of big patent expirations. But given the huge slug of revenue both drugs brought to Pfizer and Lilly, you'd think losing exclusive right to market the compounds would have hurt more. And certainly, the patent expiration has walloped the companies' income statements; further patent expirations are likely to continue the trend. Morningstar pharmaceutical-industry analyst Damien Conover estimates that Pfizer can expect generic competition to undercut gains from new drugs, to the point that sales will grow by just 1% a year on average going forward.

PFE Revenue TTM Chart

PFE Revenue TTM data by YCharts

So investors would doubtless cheer a stock-market bounce in the wake of patent expirations. But don't expect an immediate payoff. For both Pfizer and Lilly, there was pain before the gain. Lilly's share price outpaced the market before Zyprexa went off patent, but lagged for the first six months afterward. In the year before Lipitor went off patent, Pfizer shares generally lagged the broader market, only to rise steadily afterward, as the company announced various strategies to offset the lost income.

For example, Pfizer announced major cost cuts, amounting to $1 billion, and is planning another round of cuts expected to hit on December 20. The company is also expanding its sizable stock buyback program: After authorizing $10 billion in buybacks a year ago, and repurchasing $5.8 billion since then, Pfizer's board authorized another $10 billion in buybacks last month, linked to the planned sale of its nutrition to Nestlé.

Plenty of other major drugs are on the verge of going generic, of course: $290 billion in sales worth through 2018, according to one estimate cited by FiercePharma including $67 billion worth this year, and about $29 billion worth next year. On next year's hit list: Lilly's Cymbalta, Biogen's (BIIB) Avonex and Lilly's Humalog.

A rebounding business doesn't mean the stocks are buys. Pfizer, in particular, has gotten a little pricey. But like most Pharma stocks, they offer nice dividends: Pfizer's dividend yield is about 3.4% and Lilly's dividend yield is abou 4.0%.

PFE PE Ratio TTM Chart

PFE PE Ratio TTM data by YCharts

Long term, of course, what Big Pharma needs is a raft of big-selling new drugs, and the companies are pursuing that both through interview R&D efforts and via acquisitions of smaller drug development companies. But cost cutting and financial management – using cash flow to retire shares and pay attractive dividends – is also part of making Pharma stocks attractive in an era of patent expirations.

Theo Francis, a contributing editor at YCharts, is a former Wall Street Journal staff reporter.

Read more articles about: Company Analysis  

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