Given the wide divergence in opinions and expectations for Forest Laboratories (NYSE:FRX), I am a little surprised to see that the market (at least as of this writing) has reacted pretty calmly to another disappointing quarter and another miss. Importantly, the elements that led to the miss do not look all that serious and the company's long-term potential appears to be intact. That said, investors considering these shares need to appreciate that above-average volatility is likely.
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A Tough Winter Quarter
Forest Laboratories definitely didn't have the best end to calendar 2012. Revenue fell nearly 42% this quarter, and while analysts expected a sizable year-over-year decline, Forest came in about 5% shy of the average. I think how and why the company missed is important. About one-quarter of the difference (relative to sell-side expectations) came from a faster and sharper downturn in Lexapro, which now has generic competition. Another sizable chunk came from Namenda - sales of this Alzheimer's drug were up just 2% from last year (and down 6% sequentially) on greater seasonal rebating tied to Medicare Part D.
If there is a reason to worry, it comes with drugs such as Bystolic (up 20%), Daliresp (up 114%) and Viibryd (up 117%). While those year-over-year gains look impressive, the sequential performances (up 2%, down 8% and up 3%, respectively) were much less so, and some analysts will no doubt fret that the launch momentum for Daliresp and Viibryd has petered out early. Perhaps so, and I certainly would keep an eye on this, but it's worth noting that the December quarter is a tricky one in pharma and health care, as people don't always want to go to the doctor around the holidays.
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On the operational side, profits were soft. Gross margin was a little weaker than expected, and R&D expenses were substantially higher as the company booked more licensing and milestone expenses than expected.
Transitioning to the New
If Forest Laboratories is going to fill in the gaping crater created by the expiration of the Lexapro patents, its pipeline, launch and detailing activities have to go right. On the detailing front, I continue to hold the opinion that Forest Laboratories is a high-end performer when it comes to sales execution - 2013 will likely see Bystolic continue to grow at a double-digit rate, and many sell-side analysts once considered it to be not worth the bother. What's more, the company has hustled to tie up many of the potential generic competitors and potentially extend Bystolic out past 2020.
Likewise, I'm cautiously optimistic about the launches for Tudorza (chronic obstructive pulmonary disease, or COPD) and Linzess (irritable bowel syndrome, or IBS), in partnership with Ironwood Pharmaceuticals (Nasdaq:IRWD). Stocking orders looked pretty good in this quarter. Longer-term, I think Tudorza will do well against Pfizer's (NYSE:PFE) Spiriva (a $4-billion-plus drug). I'm also optimistic about Linzess, but investors should be prepared for a slower and shakier ramp - the market for IBS-constipation drugs is theoretically sizable, but there have not been enough drugs to really test those market estimates.
Beyond these launches, Forest Laboratories shareholders also have clinical data to look forward to this year. Data on LABA+LAMA in COPD should come out in the second quarter, while data on a Bystolic/Diovan combo should be out around the same time. Later this year, the company should hear from the FDA on two central nervous system drugs (one for depression, the other for schizophrenia).
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The Bottom Line
Forest Laboratories has a long history of transforming mediocre drugs (according to the sell-side) into strong revenue generators, and I don't see why that should change. Provided that the company can keep restocking its pipeline and generate data good enough for approval, I have little doubt that this company can sell its drugs effectively.
I also continue to believe that these shares are undervalued. I believe Forest Laboratories should trade in the $40s, and while the risk here is higher than average, Forest looks like one of the cheapest large drug companies today.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.