Generic Drug Stocks Take A Hit: Here's Why

It’s been a tough week for generic drugmakers which saw their shares tumbling following the release of disappointing second quarter results from Israel-based Teva Pharmaceutical Industries Limited (NYSE:TEVA) . Teva not only missed on earnings and revenue expectations, the company also slashed its 2017 outlook and announced a 75% cut in its dividend.

Teva’s shares plunged 34.1% in the two trading sessions following the release of second quarter results reflecting concerns about the company’s business and debt burden which triggered a few analyst downgrades. Year-to-date (YTD), Teva has lost 43.2% of its value versus the 12% decline of its industry

Challenging Generic Pricing Environment

A key reason for Teva’s dismal performance was generic pricing erosion. The sharp decline in generic drug prices, while a blessing for patients, is proving to be a major challenge for generic drugmakers as well as drug distributors.

On its second quarter conference call, Teva said that the ongoing consolidation of customers has led to increasing price erosion and decreasing volume. The consolidation in the industry has increased the ability to negotiate lower prices for generic drugs. Moreover, the FDA is speeding up the approval of generic drugs which means more competition, increasing price cuts and decreasing volume. Generic drugs are basically cheaper versions of branded drugs which have gone off patent.

Teva said that price erosion was around 6% in the second quarter and is expected to increase to high-single digits over the remainder of the year.

And it’s not just Teva that was affected by the tough generic pricing environment in the U.S. AmerisourceBergen Corporation (NYSE:ABC) , which reported a mixed quarter, saw its shares decline 11.4% over the two trading sessions following the release of third quarter fiscal 2017 results. The company mentioned that generic deflation remains a headwind and is yet to ease from the high single digits, where it's been for about three quarters. Generic deflation is expected to remain a headwind for the remainder of fiscal 2017 in the range of -7% to -9%. The situation may continue in fiscal 2018 as well.

Cardinal Health, Inc. (NYSE:CAH) too mentioned that generic drugs pricing was a material headwind for the company’s Pharma Distribution business in the fourth quarter of fiscal 2017. The company expects generic deflation in mid-single digits in fiscal 2018.

Stocks in Focus

Following the release of Teva’s second quarter results, companies with a presence in the generics market saw their shares declining on concerns that these companies too will be affected by the generic drug pricing environment. Companies like Mylan NV (NASDAQ:MYL) , down 10.8%), Lannett Company, Inc. (NYSE:LCI) , 10.9% down), Perrigo Company plc (NYSE:PRGO) , down 6.5%) and Impax Laboratories, Inc. (NASDAQ:IPXL) , down 10.7%) were down over the last two trading sessions. This week, investors will be focused on Mylan’s second quarter results including the company’s take on the generic pricing situation. Impax and Perrigo will also be reporting results this week. While Mylan, Perrigo and Impax are all Zacks Rank #3 (Hold) stocks, Lannett is a Zacks Rank #2 (Buy) stock. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Medical - Generic Drugs Industry 5YR % Return

In our view, generic price erosion will remain a headwind for the remainder of the year and affect the margins of generic players. With the FDA focusing on speeding up the generic drug approval process, the market will continue to witness additional competition and escalating generic price erosion.

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