3 Pharma Stocks With Big Margins of Safety

By Brian Feroldi, Sean Williams, and George BudwellFool.com

Healthcare stocks have had a rough past couple of months. The Vanguard Health Care ETF (VHT), anexchangetraded fund that tracks the returns of 342 stocks from the healthcare sector, is down more than 17% from its recent 52-week high, which could make right now a great time to go bargain hunting for the strongest names in the sector.

We asked our team of Motley Fool contributors to select a pharmaceutical stock they believe is trading at a discount to its intrinsic value, and offers investors today a good margin of safety on their purchase. Read below to see if you agree with them.

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George Budwell: I thinkAmgen offers investors one of the highest margins of safety in the pharma industry right now. If we calculate the stock's intrinsic value using free cash flow to the company, Amgen appears to have a margin of safety of around 19% at current levels.

While there's bound to be substantial debate over Amgen's intrinsic value, I think this double-digit margin of safety is at least in the correct ballpark for a few reasons.

First up, Amgen's strong clinical pipeline -- which has been bolstered by key acquisitions over the years -- has been unquestionably successful when it comes to churning out important new growth products for the company. Products such as Prolia and Kyprolis, for example, have both turned into major growth drivers for the biotech. More recently, Amgen's clinical pipeline has continued to prove its worth by generating three major regulatory approvals for the drugs Repatha, Blincyto, and Corlanor in the last year alone.

With these new products in hand, the Street now believes Amgen can grow its earnings by a healthy 12% on average for the next five consecutive years. So, while novel drug pricing schemes or fierce competitors reaching the market may cut into these lofty earnings projections, I think it's fair to say that Amgen's stock is probablyless risky than many of its biotech orpharma peers -- many of whom are seeing their top lines head south in the wake of the ongoing patent cliff.

Brian Feroldi: Its hard to think of a more rock-solid pharma company than Johnson & Johnson , as the company has a long history of treating its shareholders well in good times and bad. For the past31 consecutive years, the company has managed to grow its adjusted earnings increases,and for the past 53 years in a row, it has increased its dividend.

J&J can do that because it is so well diversified; the company counts 265 different operating companies in its fold that are spread across more than 60 countries. This gives its revenue and profits great diversity, so even if one area or region of the company is struggling, another area can help to offset any shortfalls.

And yet, despite the company's huge size, stability, and decades upon decades of paying out an ever-higher dividend, the stock is down nearly 11% year to date, and it can be purchased today for around 16 times trailing earnings, which is below the S&P 500 multiple of 18 times, which I think represents a big margin of safety. It comes with a juicy dividend yield of 3.3%, too.

While the company's massive size does limit how fast it can grow, I think investors should expect growth revenue and profit growth in the mid single digits, and when you add in the company's share repurchase program and dividend yield, the stock is certainly capable of producing double-digit returns from here. You won't be doubling your money anytime soon, but for investors looking to put money in the markets today, I think Johnson & Johnson is a great stock to buy and hold for the long term.

Sean Williams: When we're talking about "big margins of safety," I don't know howGilead Sciences couldn't be the first company out of anyone's mouth.

What makes Gilead's margins so impressive, and what essentially provides the company such a bounty of profits, is its premier position in hepatitis C.

Gilead's bread and butter are its Food and Drug Administration-approved hepatitis C therapies Sovaldi and Harvoni. Both therapies dramatically improved patient quality of life during treatment; in many cases, they shortened the length of treatment from prior-year treatments, and they improved sustained virologic response rates to 90% or greater in most clinical studies. They also come with standard 12-week wholesale costs of $84,000 for Sovaldi and $94,500 for Harvoni.

I've opined that there are only three ways to remove Gilead from its HCV throne. First, a company could attempt to trump it on efficacy, which is going to be tough after it recently reported that the combination of Sovaldi and velpatasvir led to a cure in 98% of the 1,035 patients tested (and seven of the 20 who weren't cured were simply lost to follow-up). This pan-genomic oral cure pretty much seals the deal that Gilead is the top dog in efficacy.

Secondly, a competitor could try and undercut Gilead's pricing. AbbVie tried this with Viekira Pak by forming an exclusive marketing agreement with the nation's largest pharmacy-benefit manager, but Gilead countered with steep discounts and agreements of its own with insurers and other PBMs. Even with these discounts, Gilead still managed nearly $18 billion in free cash flow over the trailing-12-month period and a gross margin of better than 86%.

Lastly, no other company has been able to top Gilead's convenience or treatment timeframe. With Harvoni working in as few as eight weeks for treatment-naive, non-cirrhotic patients, Gilead's HCV therapies remain the top choice of physicians and consumers.

With few challengers to Gilead's HCV product portfolio or pipeline, its moat of margin safety should remain practically unparalleled among pharmaceutical companies.

The article 3 Pharma Stocks With Big Margins of Safety originally appeared on Fool.com.

Brian Feroldi owns shares of Gilead Sciences. George Budwell owns shares of AbbVie, Gilead Sciences, and Johnson & Johnson. Sean Williams has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Gilead Sciences. The Motley Fool recommends Johnson & Johnson. 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.

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