Shares of FTSE 100 drug-makers Hikma Pharmaceuticals (LSE: HIK) and Shire(LSE: SHP) fell heavily on Friday, following a report that the US Department of Justice could bring criminal charges against generic manufacturers as part of an investigation into suspected price collusion.
What does this news mean for Hikma and Shire? Should you ditch these stocks right now or is this a good opportunity to buy?
A story by Bloomberg, sourced from "people familiar with the matter", said that the Justice Department's antitrust investigation, which began two years ago, "now spans more than a dozen companies and about two dozen drugs".
Hikma was not among the 12 companies named by Bloomberg, which included industry giants Mylan and Teva Pharmaceutical Industries, but the Footsie firm is the number six generics company in the US. Furthermore, it is a manufacturer of two drugs referred to in the Bloomberg story -- doxycycline and digoxin -- although, according to the Financial Times: "Analysts said the two medicines are now relatively unimportant to Hikma's US generics division".
Hikma may or may not be drawn into the investigation, but in any case antitrust inquiries are fairly common and when fines are levied they represent a one-off hit and rarely lead to any lasting damage to a company.
I'm more interested in Hikma's long-term prospects and current valuation after a 6.8% fall in its shares on Friday. In fact, at 1,620p, the shares -- now down 40% since August when the company downgraded current-year earnings guidance -- are at a two-year low.
As far as prospects are concerned, I believe Hikma has a bright future. The group generates 60% of its revenue from the US, while 34% comes from the Middle East and North Africa, which is an attractive region for high, long-term growth. The business is also nicely diversified across generics (30%), branded (30%) and injectables (40%).
As far as valuation is concerned, 2016's depressed earnings represent a bit of short-term indigestion as a result of a major acquisition. Looking ahead to 2017, and cautiously taking earnings forecasts from the lower end of analyst expectations (110p versus a consensus of 125p), we get a price-to-earnings (P/E) ratio of 14.7 and earnings growth of 25%, giving a highly attractive P/E-to-earnings growth (PEG) ratio of 0.6.
This wide margin of safety persuades me that Hikma offers excellent long-term value at the present time and I rate the shares a 'buy'.
Another very buyable stock
Shares of Shire were not hit as hard as Hikma's on Friday, falling 2.4%. They've recovered a bit today, but at 4,500p are nevertheless about 15% down from their peak last month.
Shire was not mentioned in the Bloomberg article and, indeed, doesn't have the level of exposure to the generics market as Hikma. For example, it supplies an authorised generic version of its attention deficit hyperactivity disorder drug Adderall XR on which it receives royalties.
Like Hikma, Shire has made a large acquisition this year, and in Shire's case the integration of the new business is progressing smoothly. As the leading global biotechnology company focused on rare diseases, this is another company whose growth prospects I like. And the shares look very buyable to me at a consensus 2017 P/E of 10.9 and PEG of 0.6.
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G A Chester has no position in any shares mentioned. The Motley Fool UK has recommended Hikma Pharmaceuticals. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.