In the drug sector go where the growth is: generics and emerging economies

posted on May 24

After years of worry that generic drug makers were going to destroy the profits of big U.S. drug makers, Big Pharma has figured out a solution: Buy them. Especially if the generic maker has big market share in a rapidly growing market such as India.

The latest deal has Abbott Laboratories (ABT) buying Piramal Healthcare’s generics business. The deal will make Abbott the largest drug maker in India. India is the second fastest growing drug market in the world, behind China. Piramal sells 350 branded generics in India. Annual revenue from that business is about $500 million annually and has been growing at about 20% a year.

The Indian market for drugs, now $8 billion, is projected by IMS Health to grow by 16% a year through 2014. The $300 billion U.S. market is projected to grow at a 3% annual rate.

Abbott isn’t alone. Japan’s Daiichi Sankyo (DSKYY) bought 64% of Ranbaxy Laboratories (RBXLF), India’s largest drug maker in 2008.

But the company seems almost uniquely determined to break into generics among U.S. drug makers. In March Israel-based generics superpower Teva Pharmaceutical Industries (TEVA) beat out Pfizer (PFE) to buy Ratiopharm , Germany’s second largest maker of generic medicines—and the sixth largest generic drug company in the world. The German market is the second-largest market for generics in the world next to the United States.

The advantage that an Abbott, Daiichi or Teva has over the biggest of U.S. Big Pharma is size.

Abbott’s sales were just $31 billion in 2009. Just? Sell, yes in comparison to Pfizer’s $56 billion that year. Teva is an even “smaller” with 2009 revenue of $14 billion. Daiichi Sankyo’s fiscal 2009 revenue was $11 billion. Buying a business with $500 million in revenue like Piramal’s generics unit is a more significant addition to growth at a smaller drug maker than at a Pfizer. Revenue from Piramal’s generics unit is 1.6% of Abbott’s total revenue and 3.6% of Teva’s revenue. It would be just 0.8% of Pfizer’s.

That doesn’t mean that Pfizer can’t pursue a generics strategy—just that it isn’t as motivated as an Abbott or a Teva or A Daiichi. When push comes to shove, because the deal is more important, Teva beats out Pfizer for Ratiopharm by paying more. Abbott is paying $3.7 billion, roughly a 50% premium, for Piramal.

Of course, a generic company is even more worth the price if it’s part of a strategy for a company transformation. Teva doesn’t need an overhaul—it discovered generics long ago and it’s doing very well, thank you very much.

But Abbott has recent embarked on a series of deal that has radically changed the company’s source of future growth. It bought the drug unit of Belgium’s Solvay Group in a $6.6 billion deal that closed in February. Much of the drug units $3 billion in annual sales is fast-growing emerging markets in Eastern Europe and Asia.

On May 11 Abbott also agreed to license 24 generic drugs from India’s Cadila Healthcare for sale in emerging markets.

I don’t think the stock market has yet fully valued generic drug companies. Pfizer, which grew revenue at just 0.4% a year over the last five years, trades at a P/E ratio of 14. Teva, which grew revenue by 24% a year over the last five years, earns an only slightly higher PE ratio of 16.

And I don’t think investors have caught on to Abbott Laboratories transformation at all. The shares sell at a price-to-earnings ratio of just 14.

You may not want to pick up shares of Abbott Laboratories or Teva or Daiichi now in the midst of what some days seems like a very serious correction. But keep them in mind. These generic drug stocks are where the growth is in the sector. (For more on how to handle this drop, see my posthttp://jubakpicks.com/2010/05/21/sell-sure-but-try-to-do-it-on-the-fundamentals-and-not-in-panic/ )