Bargain Alert: 3 Pharma Stocks With Solid R&D

In show business, you’re only as good as your last hit whether it’s a play, movie, or song. Oddly, the pharmaceutical business used to be the same way.

As a young pup in the mid ’90s, I remember the veteran brokers loitering around the coffee machine jabbering about pharma stocks and the drugs the companies had in their pipelines. Remember, this was when Pfizer (NYSE: PFE) had just fired the opening salvo in the Baby Boom’s second sexual revolution with its blockbuster erectile dysfunction treatment Viagra.

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However, over the last decade, as the trend of big pharma companies subbing out their research and development (R&D) to smaller, faster moving biotech companies has proliferated, you hear less chatter about Merck (NYSE: MRK) or Johnson & Johnson (NYSE: JNJ) having this or that drug in phase one, two, or three.

#-ad_banner-#Then again, maybe I’m hanging out with the wrong people or not watching the right financial news shows.

So, I decided to do some digging and find which big pharma companies had the biggest R&D pipelines. The top three were nearly neck and neck. Novartis (NYSE: NVS) won with 223 pipeline drugs in some sort of development phase. Johnson & Johnson was a close second with 216. Astra Zenneca (NYSE: AZN) was the third place finisher with 205.

But I’m not going to talk about those stocks.

Although conventional wisdom tells us to “buy the best,” I’m in the bargain-finding business. I screened the top 10 names to find the stocks with the lowest forward price-to-earnings (P/E) ratio, a value metric, and the highest dividend yield. Here are my top three:

GlaxoSmithKline (NYSE: GSK) — Headquartered in the UK, GSK spends over $5 billion annually on R&D and employs over 11,000 in the research space. The company currently has 191 projects in the pipeline with treatments targeting HIV and other infectious diseases, respiratory illnesses, oncology, autoimmune disease and inflammation, as well as vaccines.

This diligence has flowed through to the company’s fundamentals like a muscular return on equity (ROE) of 66.3%, 69% gross margins, and $5.3 billion in operating cash flow. Shares currently trade at $39.36 with a forward P/E of 13 and a solid 5.42% dividend yield.

Sanofi (NYSE: SNY) — With 179 drugs in the development pipeline, Sanofi is one of the strongest pharma names out there. The French pharma giant has aimed its research efforts at treatments for immune-inflammation, oncology, rare diseases, rare blood disorders, multiple sclerosis and neurology, diabetes, cardiovascular disease, as well as vaccines.

The company’s fundamentals are outstanding: 108% net margin growth, debt to capitalization of just 21%, and projected EPS growth of 12.8% over the next two years. Shares trade at $42.83 with a 13.4 forward P/E and an attractive 4.18% dividend yield.

Bristol-Myers Squibb (NYSE: BMY) — Rounding out the list is an American, blue chip pharma stalwart. With 134 pipeline drugs in various phases, BMY is reaching for breakthrough treatments in oncology, immunology, and fibrotic diseases. The company is also honing its R&D chops in the immuno-oncology space, which is proving to be one of the fastest-growing, “tomorrow is today” fields in pharma.

The company boasts gross margins of 71% as well as $3.5 billion in operating cash flow. Earnings per share (EPS) are projected to grow at a 16% annual clip over the next three years. Not bad for company of BMY’s girth. The stock trades at $47.72 with a 12.32 forward P/E and a 3.43% dividend yield.

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Risks To Consider: One of the biggest risks pharma companies face is the failure of a potential product. A company’s drug has a finite life as a profit center due to the fact that their patents are only good for a limited time. Once the wonder drug goes generic, literally anyone can produce and sell it. The more successes you have the more money you can make. Thus, success in the R&D space is critical and is why a company’s pipeline is always full.

One way to offset that risk is to maintain a visible portfolio of over-the-counter products. All three companies do with BMY and GSK leading the three.

Regulatory risk always looms, especially in the United States. A slower approval process and the murky path to healthcare reform create a more than normal amount of uncertainty.

Action To Take: Despite the obvious risks, all three stocks are solid plays. Plus, drug stocks typically perform better in choppier markets thanks to their defensive nature. With an average forward P/E of 12.9 and a blended 4.34% dividend yield patient investors could be rewarded with mid-teen total returns over an 18-month period holding these three as an equal weighted basket.