3 Healthcare Companies Whose Profits Can't Be Trusted

By Markets Fool.com

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Photo courtesy of Flickr, Creative Commons

Profits are the lifeblood of every business. When they dry up, the stakes are huge -- the future of theonce prosperous company is on the line.

While healthcare has been traditionally regarded as a safe haven for investors,healthcare companiescan also see their profits erode rapidly.The result isanemic returns for company shareholders, or even a nastyloss.We reached out to three Fool experts to identify healthcare stocks that could be at risk ofa profit upheaval. Here's what they told us.

Dan Caplinger: In the pharmaceutical industry, GlaxoSmithKline looks like a value investor's dream. The stock carries an earnings multiple below 7, and its dividend yield is currently well above 5%. Yet behind the scenes, Glaxo faces some big challenges that could result in a big hit to future earnings.

Like most pharma companies, Glaxo has to deal with the expiration of important treatments that drive large amounts of its revenue. Initially, Glaxo investors believed that the loss of patent protection for asthma treatment Advair might not have a huge detrimental effect, as the company said that it might be difficult for other pharmaceutical manufacturers to produce generic versions of the drug. Yet competition has hurt Advair, with similar respiratory drugs from rivals Merck and AstraZeneca costing Glaxo some of its pricing power for the drug and eating into its profit margins as well.

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For its part, Glaxo is trying to turn things around, such as through a deal with Novartisthat is helping to bolster revenue from consumer healthcare products and from vaccines. Yet given how important Advair has been to the company's overall results and with continued uncertainty about Glaxo's ability to replace those sales with newer products, investors need to watch carefully before believing that Glaxo's future earnings are truly secure.

Sean Williams: If you were to run a screen right now of healthcare companies with the beefiest profit margins, there's a really good chance that PDL BioPharma would be near the top of the list (if not at the very top).

PDL BioPharma isn't your traditional biotech company in that its purpose isn't to research clinical compounds and guide them through clinical trials. Instead, PDL BioPharma focuses on acquiring patents and royalty interests in certain drugs and profiting from the royalty revenue stream. Because its only task is to research new patents to buy and collect the revenue stream, it has very low overhead costs, and thus huge margins.

However, the downside of a royalty revenue portfolio is that branded drug patents are finite. The Food and Drug Administration issues patents good for 20 years when a company begins human clinical trials. By the time a drug reaches pharmacy shelves it has often lost a number of years of its remaining exclusivity.

PDL BioPharma has officially hit that patent "danger zone." Its Queen patents, which derive revenue from six blockbuster drugs, including cancer drugs Avastin and Herceptin, as well as multiple sclerosis drug Tysabri, expired in December 2014. What this means for PDL BioPharma is that once the remaining stockpile of its Queen licensed products has been completely sold (which could take four to six quarters), it's going to see its revenue absolutely plummet.

In its recently reported first quarter results Queen licensed product revenue totaled $127.8 million. Comparatively, the company recorded just $149.7 million in revenue in Q1, meaning Queen patents accounted for 85.4% of PDL's revenue. After reporting $581 million in revenue in 2014, Wall Street expects PDL's total revenue to shrink to less than $64 million by 2018, with EPS falling all the way from an expected $2.11 in 2015 to just $0.15 in 2018. The company's current 9% yield could also wind up just being a distant memory.

Put plainly, you can't trust PDL BioPharma's profits!

Cheryl Swanson: If you were watching a reality show featuring competing pharma heavyweights, Eli Lilly might look like a potential big winner. After all, the stock recorded a 10-year high just last month.

Don't be fooled. In Big Pharma, when generic competition enters the picture, it drives down prices and eats away profits. Eli Lilly saw its profits slide dramatically when it lost market exclusivity for its blockbusters Cymbalta, Evista, and Zyprexa. By the end of 2017, you can add to that list two more drugs: top-selling drug Alimta and Lilly's third best-seller Cialis.

While the recent launch of cancer drug Cyramza is a plus, as Motley Fool analyst Todd Campbell pointed out, the drug is "freakishly" expensive at $13,256 a month. The staggering price makes it a cost-cutting target for PBMs such as Express Scripts, which recently indicated cancer drugs are a priority, after having successfully slashed hep-C drug pricing last year.

Eli Lilly's outlook fell below analysts' expectations last quarter. The company has been resorting to cost cutting and headcount reduction to drive the bottom line, including carving $1 billion out of its struggling R&D division last year. Those cuts aren't good news for a faltering pipeline that has one of the worst records for new drug approvals in Big Pharma.

Everyone sees something different when they look at Eli Lilly. I see a company whose profits can't be trusted.

The article 3 Healthcare Companies Whose Profits Can't Be Trusted originally appeared on Fool.com.

Cheryl Swanson has no position in any stocks mentioned. Dan Caplinger has no position in any stocks mentioned. Sean Williams has no position in any stocks mentioned. The Motley Fool recommends Express Scripts. The Motley Fool owns shares of Express Scripts. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.