Home > Stock Analysis

Missing Forest Labs For The Trees

Posted: Oct 27, 2008 15:14 PM by Stephen Simpson

Tickers in this Article: AZN, BMY, MRK, PFE, SNY, FRX

Forest Labs (NYSE:FRX) is admittedly a different kind of pharmaceutical company. It doesn't have the product lineup or pipeline of a company like Pfizer (NYSE:PFE) or Sanofi-Aventis (NYSE:SNY), nor does it have the basic from-the-ground-up R&D capability of most large drug companies. Instead, Forest Labs typically in-licenses promising compounds, shepherds them through to approval, and then markets them.

Get Free Stock Analysis By Email

It's a somewhat unconventional model, and one that leaves the company vulnerable from time to time to the appearance of having big gaps in its pipeline and forward earnings. Now is one of those times, and while such periods in the past have been good buying opportunities, is that the case here today?

Still a (Mostly) One-Product Company
Overall product revenue was up 10% this quarter, with sales of the anti-depressant Lexapro up 4.4% and making up about 63% of total revenue. Gross margins ticked up slightly, and operating income jumped 23% as the company spent 14% less on research and development. Unlike most pharmaceutical and med-tech companies, declining R&D spending is not quite a red flag for Forest Labs, as the company doesn't really conduct significant early-stage research and the R&D figure jumps around on licensing payouts.

The Pipeline to Profit
Where Forest Labs is like other drug companies is in the significance of the pipeline. Simply put, the pipeline is the source of future revenue, cash flow and growth. At present, Forest's pipeline is somewhat constricted.

The company is hoping to file a new drug application for aclidinium in the treatment of chronic obstructive pulmonary disease in late 2009. If approved, this drug would compete with Spiriva (marketed by Pfizer and Boehringer Ingelheim), but clinical data has been mixed as the drug seems less effective but safer.

Elsewhere, the company has seen the FDA push out a decision of milnacipran (for fibromyalgia), and is waiting for additional clinical data on drugs targeted at pneumonia, schizophrenia, skin infections and a form of irritable bowel syndrome.

After the company's earnings report, Forest Labs announced a new drug partnership that adds another drug to the pipeline. In a deal with Phenomix, Forest has acquired the rights to dutogliptin, a DPP-4 inhibitor currently in Phase 3 studies for Type 2 diabetes. Should it get approved, Forest will likely be launching the drug in competition with Merck's (NYSE:MRK) Januvia (which is already doing quite well), Takeda's alogliptin, and also saxagliptin from Bristol-Myers Squibb (NYSE:BMY) and AstraZeneca (NYSE:AZN), to say nothing of a host of other diabetes drugs like GLP-1 inhibitors. (For more, see Measuring The Medicine Makers.)

Although I think DPP-4's could represent upward of $5 billion in revenue potential in a few years, Forest will need to spend a lot of money to get the drug to market, and a lot of money marketing it once it gets there. On the other hand, Forest does have experience in marketing drugs that are late to the party (like their current drug Benicar).

Familiar Tune
With stocks getting hammered left and right, it's hard to say that Forest Labs has been particularly ill-treated. Nevertheless, I'm sure there are some investors concerned about the pipeline and the eventual generic competition for drugs like Lexapro and Namenda. To them I would say that Forest has always moved at its own pace with regard to refilling its pipeline, and I doubt that they will just sit on $2.6 billion in cash. I think Forest shares are trading too cheaply today, even when you consider that many large pharmaceutical companies will be in the market to strengthen their pipeline (thus pushing up the price for Forest). Investors will need some patience and will have to make peace with Forest's unconventional model, but it's a model that has worked for a long time already.

By Stephen Simpson

Stephen Simpson, CFA, has worked as an equity analyst for both sell-side and buy-side investment companies, and presently works as a sell-side equity research analyst. He has worked as a consultant for the healthcare sector, and has written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson is the editor of Kratisto Investing, a website devoted to financial analysis and personal commentary.

Rate this Article: Your Rating: Overall Rating: Vote Now!

MORE STOCK ANALYSIS