The healthcare sector is an attractive hunting ground for stocks due to its economic resilence and patent-protected earnings. But even here there are still plenty of companies I wouldn’t touch with a barge pole. Take Shire Pharmaceuticals, Britain’s third-largest drug maker.
Shire Pharmaceuticals (LSE:SHP), tipped as a BUY by The Independent
It specialises in attention-deficit and hyperactivity disorders (ADHD), with its blockbuster Adderall and rapidly growing Vyvanse treatments being the leaders in the field. Shire has also branched out into niche human genetic therapies and gastrointestinal diseases, such as its treatment for Hunter’s syndrome, a debilitating genetic disorder that affects about 2,000 young people in America.
Last week’s results showed that 2008 sales rose 24% to $3bn. Underlying EPS leaped 36% to $1.28 (or 86p at £:$ = 1.5), putting the stock on a tasty 10.2 p/e multiple. But don’t be sucked into this value trap: it’s a mirage. Adderall, which accounts for 36% (or $1.1bn) of sales, will face generic competition from April. This will have a huge impact, since sales of drugs that lose patent protection fall by around 80% almost overnight. The saving grace is that the rest of the medicine cabinet looks secure, while replacement product Vyvanse continues to grow rapidly since being launched in 2007. But I still expect the top line to decline over the next two years – settling down at about $2.5bn in 2010 and delivering EPS of approx $0.75 (or 50p). On this basis, the stock looks far more expensive, trading on a racy 2010 p/e ratio of 18.
Another major concern is how Shire’s pipeline will fare going forward. It has 16 treatments in phase II or III clinical trials, or awaiting approval from the US Food & Drug Administration. Shire’s chief executive, Angus Russell, expects all these to succeed over the next six years and to help the group raise turnover by more than 10% a year between 2010 and 2015. I don’t share his optimism. Typically there is a high attrition rate for drugs going through late-stage human testing. As a rule of thumb, less than half of all compounds in phase II/III trials make it onto the doctor’s prescription list. Based on this more conservative benchmark, I would estimate the whole company is worth about 650p a share, or 25% less than today. And although Shire already has a hefty debt pile (£853m), the firm still plans to make a long list of further acquisitions. Shire’s need to beef up its portfolio could easily lead it to overpay for these.
Recommendation: SELL at 902p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments.