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Undervalued Opportunities in Specialty Pharma

Though low earnings multiples are justified for many companies in this beleaguered industry, a handful of players look relatively safe and undervalued at current levels, says Morningstar's Michael Waterhouse.

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Michael Waterhouse: The specialty pharma industry has been under considerable pressure since late last year, creating some pockets of investing opportunities for certain companies. Most of these companies' operations include a mix of branded and generic drug segments, which have both faced considerable challenges. On the branded drug side, many of these companies have considerable patent expirations, little pricing power, and insufficient pipelines to support future growth. In the generics side, fewer large patent expirations in the U.S., weak pricing in Europe, and tough competitive pressures leave a lackluster growth outlook.

Although we do think low earnings multiples are therefore justified for most of these companies, we do think a handful of players with healthy economic moats should be able to overcome industry challenges, and look relatively safe and undervalued at current levels. There are three names I'd mention in particular. Allergan remains the only wide-moat name in the space and has one of the best growth outlooks thanks to its defensible products and healthy pipeline. We also think its merger with Pfizer will be completed this year. Second, Perrigo, a niche generic drug manufacturer in over-the-counter products which is relatively is immune to much of reimbursement fears currently in the industry. Lastly Teva, which is the largest generic drug manufacturer, looks relatively undervalued despite  ignificant headwinds from generic competition on its largest branded product, Copaxone.

Michael Waterhouse does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.