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A “Dividend Aristocrat” to Beat the Generic Drug Bloodbath

Short sellers of generic biotech stocks are wreaking more havoc than a tornado in a trailer park. Global generic drug makers have been getting pounded over the past week, a sell-off triggered in large part by horrific second-quarter results from industry bellwether Teva Pharmaceutical Industries (NYSE: TEVA).

However, remember this timeless contrarian advice: one investor’s bloodbath is another’s buffet. Below, I pinpoint a generic pharmaceutical play that’s not only weathering the storm but also positioned to soar when the generic drug business inevitably bounces back. First, let’s breakdown the continuing slaughter in this sector — its reasons, extent and aftermath.

Falling prices for generic drugs, although a benefit for consumers, have been weighing on drug companies of all types. The U.S. Food and Drug Administration has been speeding-up its approval of generic drugs while at the same time the industry has been consolidating to achieve economies of scale and cost efficiencies.

But there’s an unexpected twist to this story. Major pharmaceutical companies have started squeezing profits from more expensive brand-name drugs by pressuring the retail supply chain to favor them over generics. Through rebates and other incentives, Big Pharma is getting drugstores and health care providers to increasingly prescribe brand name drugs over generics, giving consumers little choice but to pay more. This Alice-in-Wonderland pricing environment has caught generic drug makers in a double bind.

The upshot has been severe generic drug price erosion. Fueling price pressure is the Affordable Care Act, aka Obamacare, which enforces strict cost control measures on health services and drugs. Last month’s demise of Trumpcare only solidifies this trend, because it leaves Obamacare and its cost-containment provisions in place.

The Teva Apocalypse

Leading the industry’s devastation has been Teva Pharmaceutical Industries, the largest generic drug maker in the world. Based in Israel and with operations around the world, Teva is renowned for its leading-edge drug research and a portfolio of quality products. But industry headwinds have been too much for Teva.

As a whole, second-quarter corporate earnings have been robust. Teva, though, fell flat on its face. The company last Thursday reported second-quarter earnings per share (EPS) of 99 cents, which missed the consensus EPS estimate of $1.06 by 6.6%. EPS in the same period a year ago was $1.22.

Teva’s revenue of $5.6 billion missed consensus expectations of $5.85 billion by 2.8%. In response to the plunge in earnings as well as its shrinking cash flow, the beleaguered company cut its dividend and slashed earnings and revenue guidance for full-year 2017.

Wall Street’s reaction was swift and brutal. The stock got pounded on Thursday, Friday and Monday, losing more than a third of its value. Teva stock is now down 48.7% year to date, hitting its lowest levels since 2003. Ouch.

It doesn’t help that Teva has been on the hunt for a new CEO ever since current honcho Erez Vigodman said in February that he would step down.

I actually think Teva possesses several inherent strengths, including a powerful and proven R&D capability, that will come to the fore over the long haul. But until the company finds a new CEO to right the ship, stay away from the stock. It’s not a value play; right now it’s a value trap.

Teva’s miserable earnings report underscored widespread troubles in the generic drug business and dragged down the company’s main rivals as well. Also taking it on the chin since Thursday have been Perrigo (NYSE: PRGO), Dr. Reddy’s Laboratories (NYSE: RDY), Endo International (NSDQ: ENDP), Mylan (NSDQ: MYL), and Taro Pharmaceutical (NYSE: TARO).

The VanEck Vectors Generic Drugs ETF (NSDQ: GNRX) dropped 4.1% on Thursday and year to date has generated a total return of only 4.9%, compared to 11.4% for the S&P 500.

Companies focused on generics have taken the worst beating over the past week, while Big Pharma stocks with brand name blockbusters have held up relatively well. Indeed, the iShares Nasdaq Biotechnology ETF (NSDQ: IBB) has generated a total return of 20.4% year to date.

A shrewd strategy now is to pick a blue-chip drug maker with a foot in both the generic and branded worlds, with diverse activities in the health sector. The generic drug business isn’t going away and its eventual turnaround will provide a profit catalyst for the best stocks to breakout.

A Survivor in Aristocratic Clothing

All of which brings me to Chicago-based Abbott Laboratories (NYSE: ABT), a drug maker that’s on the list of “Dividend Aristocrats.” Abbott can survive the sustained pressure on generic drug prices but also boasts sufficient product diversity to withstand future turbulence in the broader stock market.

To earn the honored title of Dividend Aristocrat, a company must typically have raised dividends for at least 25 years. More precisely, the company must have a dividend policy that increased its dividend every year for those 25 years.

Abbott consistently makes S&P’s list of Dividend Aristocrats and 2017 was no exception. Keep in mind, a proven hedge against looming stock market corrections is to increase your portfolio’s weighting toward proven dividend-paying stocks.

If the broader indices tumble this year as I expect, the best dividend-paying stocks should generate less volatility and provide a cushion for risk-averse investors.

Well-established companies such as Abbott that dole out regular dividends tend to outperform the overall market over both the short and long haul. Since 1927, dividend-paying stocks have returned 11% per year versus 8% for non-dividend paying stocks. In June, Abbott declared its 374th consecutive quarterly dividend to be paid since 1924.

With a market cap of $85.4 billion, Abbott serves customers in more than 150 countries and employs approximately 70,000 people. The company operates internationally across four business segments: Branded Generics, Medical Devices, Diagnostics and Nutrition. These businesses provide a diversified customer base and payer mix.

The company’s drug portfolio includes Humira, for rheumatoid arthritis, psoriatic arthritis, Crohn’s disease, and psoriasis; Norvir, for HIV; Depakote, an anticonvulsant; and Synthroid, a synthetic thyroid hormone.

Abbott also offers a wide range of medical devices and diagnostic tests used worldwide by doctor’s offices, hospitals, laboratories, and blood banks to diagnose, monitor and treat diseases such as cancer, HIV, hepatitis, heart failure and metabolic disorders.

Abbott reported second-quarter worldwide sales of $6.6 billion, a year-over-year increase of 24.4%. EPS came in at 62 cents, exceeding the previous guidance range of 59 cents to 61 cents. Management raised its full-year 2017 EPS guidance range, reflecting expectations of double-digit growth.

The average analyst expectation is that ABT’s year-over-year earnings growth will reach 10.2% in the current quarter, 12.3% next quarter, 13.2% in the current year, and 11.6% next year. My own calculations show that ABT’s five-year earnings growth should reach at least 11% on an annualized basis.

The annual yield on ABT’s dividend is 2.15%. Abbott’s stock is now poised for outsized growth, as it taps into some of the health sector’s biggest opportunities and leapfrogs the woes currently bedeviling the generic drug sector. Year to date, ABT shares are up 28.3%, with further upside in the cards.

 

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