This "Cheap" Stock May Not Be a Bargain

Impax Labs operates both a generic-drug business and a specialty drug business, but its generic-drug business is the bigger of the two businesses and, unfortunately for investors, it is struggling this year.

In the second quarter, an unexpectedly sharp drop in sales of the Impax Labs' generic diclofenac led to big dropoff in generic-drug revenue and profitability. Impax came into this year as the only company selling diclofenac, but it exited Q2 as one of five companies vying for market share. As a result, its sales of diclofenac were just $5 million in Q2, down from $88 million in Q4.

The rapid loss of diclofenac market share was surprising and that weakness, coupled with falling sales of two other important medicines -- metaxalone and mixed amphetamine salts -- caused a 30.3% drop in total generic-drug revenue and a 19% drop in companywide second-quarter sales compared to a year ago.

The poor performance forced management to revise the company's full-year financial guidance significantly lower and it stole some of the thunder away from its recent acquisition of 15 generic drugs from Teva Pharmaceutical (NYSE: TEVA).

In July,Teva Pharmaceutical sold those 15 drugs to Impax Labs so that it could win support from federal regulators for its purchase of Allergan's generic-drug business. Impax Labs had to take on debt to finance the $586 million purchase, but the deal added $150 million in 2015 sales and management thinks the acquisition will be handsomely profitable. The company thinks these drugs couldadd 20% to earnings in the coming year and that had analysts estimating EPS of $2.55 next year.

Based on those estimates, investors hunting for low valuation stocks might be drawn to Impax Labs' stock. However, following the second-quarter results, those estimates could head lower, and if they do, then Impax Labs' forward valuation might get a lot less attractive.

Looking ahead

Management ratcheted down its full-year sales forecast from $989 million earlier in the year to between $900 million and $940 million this year. It also cut its EPS target from at least $1.74 to between $1.57 and $1.70.

The cuts to guidance are especially disappointing because the company's specialty drug business continues to grow. Specialty drug revenue increased year over year by $11.4 million to $50.9 million last quarter. Absent the company's second-quarter generics stumble, investors would probably be flocking to shares based on the specialty drug business and the Teva Pharmaceutical deal.

Unfortunately, the uncertainty regarding sales and profitability makes it too tough to accurately value Impax Labs' shares, and because of that, investors should probably be buying other "cheap" stocks instead.

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Todd Campbell has no position in any stocks mentioned.Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may have positions in the companies mentioned. Like this article? Follow him onTwitter where he goes by the handle@ebcapital to see more articles like this.The Motley Fool recommends Teva Pharmaceutical Industries. 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.