A Miraculous Recovery For No Name DrugsJoseph Weber
Only a couple of years ago, there seemed to be nothing the generic-drug industry could do right. It was reeling from revelations that one company was submitting doctored brand-name drugs in new-product applications to the Food & Drug Administration. Another was found to be bribing FDA examiners. Amid all the bad news, investors stayed away in droves, even from the straight-shooting outfits.
Now, however, the copycats are surging back. Investors who expect money-saving generic drugs to play a central role in health care are dizzily bidding up prices again. An index of seven generic stocks hit an all-time high in January--more than double its early 1991 level--and, after dipping in recent months, it has again turned upward. Says John H. Klein, chief executive of Zenith Laboratories Inc., a small New Jersey-based generic manufacturer: "This industry has rebuilt itself."
AWASH IN CASH. Time for investors to move to the sidelines? Probably not. Although the stocks of most generic makers are selling at price-earnings ratios well above the overall market average of 23, the prospects are so favorable that revenues and profits should roar ahead for some time. Over the next five years, branded drugs worth nearly $20 billion a year in sales are expected to go off patent. Among them: such giant products as SmithKline Beecham PLC's ulcer treatment, Tagamet, and Bristol-Myers Squibb Co.'s blockbuster antihypertensive, Capoten. If the generic makers can capture just a third of the formerly branded-product dollars--a reasonable goal, since generics typically sell for half or less than branded items--they will be awash in cash.
The industry is sure to get a boost from Washington. Whenever the Clinton health-care reforms go into place, they will almost surely favor low-price generic substitutions for off-patent drugs. Already, generics account for well over half the new prescriptions filled for some ailments, thanks to preferences given by insurers and managed-care providers. In growing numbers of private and public programs, usage of generics may well become mandatory.
Regulatory problems that hobbled the industry, too, seem behind it. The FDA scandal so overwhelmed the agency that approvals of generic applications slowed sharply. The FDA has reorganized the unit that approves generics. Along with mandating tighter oversight, it has broken the logjam on new approvals and is cutting deeply into a backlog of applications. "Things had really slowed," recalls Roy McKnight, CEO of Mylan Laboratories Inc. The Pittsburgh-based drugmaker hopes to get approval for some 20 drugs in the next two years. Mylan's sales in fiscal 1993, ended Mar. 31, hit $212 million and should rise 30% in 1994, to $275 million. Earnings could vault to $84 million next fiscal year, from $70.6 million in 1993.
For all the growth ahead, price competition will narrow margins among the companies that rush to market with copies of such megadrugs as Tagamet. Says PaineWebber Inc. health-care analyst Tina Rizopoulos: "You want to invest in areas where generic companies can create a market dominance, a market franchise."
MIST OPPORTUNITY. The best performers will likely be niche players. Companies that specialize in producing hard-to-copy drugs or dominate certain therapeutic segments should have a leg up. A.L. Laboratories, for one, is drawing a lot of notice from analysts who like the company's franchises in liquid medicines and over-the-counter generic drugs. It markets an antidiarrheal that competes with Johnson & Johnson's Imodium A-D. On May 6, the company won FDA approval to market Epinephrine Mist, a generic equivalent of Primatene Mist and Bronkaid Mist. A.L. Labs' sales should reach $350 million this year, up from $295.1 million in 1992. Earnings from continuing operations could move from $11.4 million last year, to between $17 million and $20 million, says independent drug analyst Hemant K. Shah.
Generic houses, to be sure, won't have the field all to themselves. Many big drugmakers already are in the business, and they are stepping up operations. Merck & Co. will be producing 11 off-patent drugs in a new generic subsidiary, West Point Pharma. And American Home Products Corp. announced on May 10 that its newly formed ESI-Pharma unit will sell a broad line of generics, starting with a lookalike of rival Upjohn Co.'s synthetic-hormone drug, Provera, for treatment of abnormal bleeding. Generic makers contend that their giant rivals can't move quickly enough and predict the big houses' overhead will hobble them.
Still, competition will surely intensify, and margins will surely narrow. But the market for generics is expanding so fast that the copycats could still be in the cat-bird seat for years to come.