Boring Is Beautiful

 | Oct 01, 2012 | 11:00 AM EDT  | Comments
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I am getting increasingly cautious on the overall market amid uncertainty from the fiscal cliff, lack of resolution in Europe and the upcoming elections. Also disconcerting are the continued declines in the world's manufacturing indices, as well as the first negative monthly Institute for Supply Management survey since 2009. That's not to mention the recent downward second-quarter gross domestic product revision to an anemic 1.3%.

I think discretion is the better part of valor here. One defensive sector I still like -- due to its reasonable valuations, low betas and reliable earnings streams -- is the generic drug area. It may be boring, but it should perform well even in this economic uncertainty.

The industry is likely to continue benefiting from several long-term secular trends, as well. One is the aging of the population in the developed countries. Another is that strained government budgets -- state, federal and foreign -- are putting pressure on reducing drug costs in medical-entitlement spending. Finally, there are the continued expirations of key patents on blockbuster drugs throughout the industry. Following, then, are two companies I think will continue to thrive even in uncertain times.

Watson Pharmaceuticals (WPI) is a specialty pharmaceutical company that makes and distributes generic and brand pharmaceutical products worldwide. Here are four reasons Watson is a solid buy at $85 a share.

1. The company's earnings growth is accelerating on the back of its acquisition of Swiss generic drugmaker Actavis. Watson made $4.77 a share in 2011, and is on track to earn more than $5.75 this year. Analysts are targeting more than $8 in earnings per share for 2012.

2. Watson has completed a series of successful acquisitions over the past decade. It should wring at least $300 million in cost synergies out of this latest acquisition, and this should also be very accretive to earnings.

3. The company rarely disappoints: It has met or beaten analysts' earnings in estimates each of the last 12 quarters. Consensus earnings estimates for both 2012 and 2013 have ticked up over the last three months, even as we've seen overall compression in third-quarter estimate for S&P 500 companies.

4. Watson is selling at just 10.5x forward earnings, a discount to its five-year average of 13.3x, and the stock has a low beta of 0.37. The company has grown EPS at better than a 25% annual clip over the past five years, so shares seem to be giving investors a good entry point.

Mylan (MYL) develops branded generic and specialty pharmaceutical worldwide. Here are four reasons the stock offers solid value at $24 a share:

1. Even after its recent run, the stock is selling near the bottom of its five-year valuation range, based on its price-to-earnings, price-to-sales, price-to-book and price-to-cash-flow multiples.

2. Mylan is showing solid earnings growth. It made more than $2 a share in earnings in 2011 and should post more than $2.50 a share in earnings this year. Currently analysts have $2.75 in earnings pegged for 2013.

3. This low-beta (0.84) stock is selling for less than 9x forward earnings, a significant discount to its five-year average of 14.3x.

4. Mylan has grown revenue at a 20% annual pace over the past five years -- and yet, for its P/E ratio relative to growth (PEG), it sports a five-year reading of 0.92, under the widely accepted 1.0 threshold.

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