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The Best Health Care Stock To Own Right Now

Thursday, July 24, 2014 8:30 AM

Although investing is about making money, I've noticed that losses are what really stick out in people's minds.

If their advisor tells them their portfolio is up say 7% this year, they'll come back with something like "Yeah, but if such-and-such investment hadn't tanked, I'd be up 10%."

Because the pain of losses tends to outweigh the thrill of gains, I always try to identify firms that can grow faster than average without excessive risk. One in particular fits this description very nicely, and a big reason I'm bullish on it is it's in the health care sector.

Obviously, being in health care doesn't automatically confer a lower-risk, higher-reward profile. Lots of stocks in the sector could easily lose you buckets of money very fast.

But let's face it, populations in the developed world are aging and increasingly in need of all types of health care. That'll continue to be great for the profits of well-established health care firms with specific competitive advantages and diverse, evolving product lines -- like the firm I just mentioned, Actavis (NYSE: ACT), the world's third-largest generic drug manufacturer.

The company, previously known as Watson Pharmaceuticals, achieved that status in late 2012 when it bought the large Swiss generic drugmaker Actavis Group (and decided to drop the Watson name). If you examine Actavis' latest annual report, it should quickly become apparent the firm has the sort of product diversity necessary to support strong growth while protecting itself -- and shareholders -- from losses.

Actavis Pharma, the segment mainly responsible for generic drugs, is the company's largest revenue source with 73% of total sales (currently $9.4 billion a year). After a big year of product launches in 2013, when Actavis Pharma introduced about 700 new offerings, the segment now sells nearly 1,000 generics in the U.S. and abroad.

A few key examples include a lidocaine patch that is the generic version of the topical anesthetic Lidoderm; bupropion, the generic form of the antidepressant Wellbutrin; and methylphenidate, which is generic Concerta, a drug for both hypertension and attention deficit/hyperactivity disorder. Generic antibiotics, prescription pain relievers, and diabetes medications are also among the products in the Actavis Pharma portfolio.

Anda Distribution, Actavis' #2 business segment, generates 14% of revenue by distributing for Actavis and other pharmaceutical firms to outlets like chain and independent drugstores, pharmacy buying groups and doctors' offices. Anda, which is known for quality customer service, typically stocks about 15,000 products and supports operations with two big distribution centers in Florida and Ohio.

Actavis Specialty Brands is the company's smallest segment, with 13% of revenue. As its name suggests, the segment mainly sells branded pharmaceuticals, and its 45-product portfolio includes things like osteoporosis drugs Actonel and Atelvia; oral contraceptives Generess, Lo Loestrin and Minastrin; and bladder treatments Enablex and Oxytrol.

While specialty brands has long been its #3 segment in sales, Actavis has smartly been looking to expand it to reduce reliance on generics, which typically carry lower margins and could offer fewer growth opportunities in the future as patent expirations tail off. In fact, the firm more than doubled its branded drug portfolio to the present size when it bought Ireland-based drug maker Warner Chilcott for $8.5 billion last year.

The buyout immediately made Actavis a major force in the global markets for medications related to women's health, gastroenterology, and dermatology. As Actavis' management notes, the buyout also "delivered an industry-leading pipeline with more than 25 products in various stages of development... and provides the opportunity to introduce a broader portfolio of new products in Actavis' expanded global footprint."

On July 2, Actavis closed a $28 billion acquisition of New York City-based Forest Labs, which came with a sizable portfolio of brand-name drugs for depression, hypertension and allergies, among other conditions. The same day, Actavis completed a $1.1 billion buyout of a small firm called Furiex Pharmaceuticals, which had developed what could be a blockbuster treatment for irritable bowel syndrome. The drug, eluxadoline, could be approved by the FDA this year.

Although specialty brands has been the focus of major acquisitions recently, Actavis plans to augment the core generics business, too. On July 9 for instance, it filed for FDA approval to market a generic version of the multiple sclerosis drug Ampyra, which has strong sales of $231 million a year. Actavis filed another such application on July 11 for Diclegis, a resurgent treatment for morning sickness that could also easily see hundreds of millions in annual sales.

Risks to Consider: To support its recent M&A activity, Actavis has substantially increased its leverage and now has a debt-to-equity ratio of 0.9 -- nearly twice the industry average of 0.5.

Action to Take --> Because of its new revenue sources, Actavis' sales are projected to grow to about $15 billion next year, compared with $9.4 billion during the past 12 months. Management estimates free cash flow of over $4 billion in 2015, which they expect will allow them to reduce the company's leverage.

Although the firm is currently operating at a per-share loss of $3.60, analysts project earnings will soar to $16.61 a share in 2015. This gives the stock a cheap-looking forward price-to-earnings (P/E) ratio of just 13 and implies 45% upside in the coming 17 months -- assuming a very conservative P/E of 19, which is well below Actavis's long-term average of 33.

With such a cheap valuation and high likelihood of fast growth, Actavis currently appears to fit the lower-risk, higher-reward profile most investors are looking for.

The only thing better than investing in high-quality companies is investing in high-quality companies that return money directly to shareholders. In our latest research, we've found 13 market-dominating companies that have been hoarding billions in cash since the financial crisis -- and they're set to pay out $39.5 billion in dividends in 2014 alone. For access to the names and ticker symbols of some of these companies, follow this link.

Tim Begany does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.