The Health Care Reform Winner

Some things are universally true. No one ever went broke taking a profit, for instance.

Also: Companies that offer lower costs always have a significant competitive edge.

This is becoming especially true for companies in the health-care field as cost becomes an ever more important element of patient choice. Companies that can offer such an advantage to consumers will be the winners in the debate over health-care reform, regardless of which bill gets passed when.

Case in point: Despite a -1.3% drop in consumer prices, brand-name prescription drugs prices have risen by about +9% this year. Generic drug prices, on the other hand, have fallen by about -9%. As a result, members of Congress have asked for two separate investigations of drug pricing.

Large drug companies are facing tough challenges. Several major drugs — such as Pfizer’s (NYSE: PFE) cholesterol-lowering Lipitor, the No. 1 selling drug in the world — are scheduled to lose patent protection soon. An estimated $137 billion of drug sales will lose patent protection within the next five years, according to IMS Health, which provides sales analysis and medical audits to the pharmaceutical industry. The problem is so severe, the industry has termed it the “patent cliff.”

Once a drug loses patent protection, it becomes vulnerable to generic competition. Generics count for about 70% of prescriptions in the United States, and patients are increasingly using them as a less expensive alternative to name-brand pharmaceuticals.

It’s not hard to see why: The average generic drug costs $34.34 compared with $119.51 for a brand-name equivalent. Generic medicines saved the American health care system more than $700 billion between 1999 and 2008.

The future for generic drug companies is bright. Here are some of the beneficiaries:

Generic Drug Makers 2008 Revenue % from Generics Operating Margin Forward P/E
Teva Pharmaceuticals (Nasdaq: TEVA $11.0B 67% 24.0% 11.7
(Nasdaq: MYL)
$5.1B 82% 13.6% 14.1
Watson Pharma (NYSE: WPI) $2.5B 58% 14.1% 21.1
Dr. Reddy’s Lab (NYSE: RDY) $1.5B 69% 13.4% 13.4

In this case, the clear leader is already at the top of the list: Teva Pharmaceuticals (Nasdaq: TEVA). Headquartered in Israel, Teva is the world’s largest generic drug company. It sells about 470 generic drugs, which brought in $11 billion in revenue last year. As the market leader in an industry that will directly benefit from big pharma’s woes and the American consumer’s increasing need for cheaper medication, Teva is in an enviable position.

Teva recently bought Barr Pharmaceuticals, another generic drug maker, for $7.6 billion. This deal will only solidify Teva’s position as the market leader in generic drugs.

Teva is expected to deliver annual sales growth of +18% within the next five years. The company’s shares are trading at less than 12 times forward earnings, a significant discount to its peers in the table above. As the world-class leader in an industry expected to grow +8% annually, the shares look to be a bargain.