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Why the FDA's Drug Competition Action Plan Is Bad News for Generic Pharmaceutical Stocks

It is no secret that prescription drug prices in America are the highest among all developed nations. A variety of factors have contributed to the issue, such as a lack of universal healthcare coverage, the staggering cost of conducting clinical trials to get drugs to approval, and price gouging by sector players with questionable motives.

The problem has not gone unnoticed. Since 2017, the U.S. Food and Drug Administration (FDA) has been conducting an initiative called the Drug Competition Action Plan to make prescription drugs more affordable. The campaign is working well, but it comes at the expense of lower revenue and profits for many sector players. What does this mean for investors? Let's find out together.

Image Source: Getty Images.

What the FDA is doing

To put it simply, the FDA is devoting significant resources to expedite the approval of copycat drugs. Last year, the administrative body approved a record 1,171 generic drugs, a 21% increase from 2018 -- itself a year of record approvals. That's more than three generic drugs approved every day!

Typically, branded drugs derive their revenue from the patent protection and market exclusivity they receive, allowing their makers a legal monopoly until the drugs lose their intellectual property protection. After their patents expire or generic manufacturers successfully challenge them in court, branded drugs can see their revenue decline by 80% to 90% in as little as 12 months due to fierce competition from copycat drugs.

For example, Pfizer's (NYSE: PFE) once-blockbuster cholesterol reduction drug, Lipitor, saw its annual revenue plummet from $5 billion in 2011 to about $932,000 just a year later. The more copycat drugs the FDA approves, the more options patients have, which in turn reduces the prices of all drugs targeting an indication.

How sector players are doing

For generic manufacturers with a significant portion of their revenue coming from the U.S., the new initiative has done nothing less than wreak havoc on the bottom line. Take the case of Lannett Company (NYSE: LCI), which conducts more than 90% of its business operations in America.

Revenue at Lannett declined by 16.4% year over year in the past quarter. Worse, its non-GAAP (adjusted) earnings per share declined further -- by more than 60% year over year. These developments spell out a lot of trouble for a company with a debt-to-equity ratio of more than 200%.

Meanwhile, sector players that are profitable with little to no debt are seeing their margins shrink. For example, gross margins at ANI Pharmaceuticals (NASDAQ: ANIP) were slashed by 1,450 basis points year over year to 58%; at Taro Pharmaceutical Industries (NYSE: TARO), that number was 790. Both companies also saw their revenue decline by about 3% to 6% compared to last year.

To put it mildly, the FDA wants to make changes, and it seems to have little concern over how this affects companies. Recently, Akorn, a generic drug company with 100% of its business coming from the U.S., filed for bankruptcy protection. Back in 2017, the company was valued at $4.3 billion.

Is there hope?

Luckily, not all generic pharmaceutical companies conduct all their operations in the U.S. Those with healthy international segments are in luck, because the FDA's new initiative does not affect other areas of the world. For example, Teva and Mylan (NASDAQ: MYL) are seeing their revenue and earnings per share grow, primarily because 52% and 63% of their revenue, respectively, comes from outside North America.

Ample money can be made by investors wishing to ride these companies' rebound. But for the others named in this article, it's probably best to avoid them permanently, as drug prices will not be rebounding anytime soon.

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Zhiyuan Sun owns shares of ANI Pharmaceuticals. The Motley Fool recommends Mylan. The Motley Fool has a disclosure policy.


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