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Bobby Raines's Analyst Insights

Options Analyst Writer
Bobby Raines
Author Bio

February 04, 2013 - Let Allergan Pump Up Your Wallet

The pharmaceutical sector is an interesting one for investors. Most drugs are paid for in part or entirely by health insurers, which helps insulate drug sales from the ups and downs of consumer spending. This can make certain parts of the sector a defensive play.

The pharmaceutical sector can be pretty volatile though. The process of developing and bringing new drugs to market can be exceptionally costly and usually takes years. This tremendous investment needs to be recovered relatively quickly, as drug makers lose exclusivity after a few years, (it varies depending on the type of drug) and patents expire after 20 years. Once those things happen, competition increases and a company's chances of recouping its initial investment basically disappear.  Other risks to pharmaceutical companies include the rejection of a drug part of the way through the approval process, or, even worse, the discovery of new health risks after a drug has been on the market for a while.

While pharmaceutical stocks can be a good defensive play, many of the major drug companies don't always see a lot of upside from an improving economy. One company that could see better performance in a better economy though is Allergan. The company makes ophthalmic, neuromuscular and skin care pharmaceuticals, the best known of which is Botox.

Originally developed to treat neuromuscular disorders, Botox has become a widely used cosmetic treatment for removing facial wrinkles. It isn't the company's only product designed to change people's appearance though. The company also makes breast implants, lap-bands and drugs to treat acne and lengthen eyelashes.

The biggest part of the company's revenue comes from eye-care drugs, with 47% of sales coming from products to treat glaucoma, inflammation, infection, allergies and dry eyes. This gives the company a solid, steady revenue base to build on while the cosmetics business is understandably more exposed to consumer spending.

Allergan recently agreed to acquire Map Pharmaceuticals, a company with which it . The company and Map previously had a 50/50 partnership to develop Levadex, an inhaled drug for acute migraines. The purchase indicates that Allergan is optimistic about the drug's outlook for approval and subsequent sales.

Investors will get an idea of how smart that move was on April 15, when the FDA is scheduled to rule on Levadex. Before that though, the company is scheduled to report earnings on Feb. 5. Analysts expect the company to earn $1.19 per share, compared to $1.00 per share in the same quarter of 2011.

Allergan has missed earnings estimates only once in the last seven quarters, and that miss was by a penny per share. Analysts seem pretty confident in their estimates as only one of the 26 analysts who cover the stock has changed estimates in the last month.

Take a look at a bull-put credit spread on AGN such as the April 92.50/97.50 for a credit of 50 cents. That's good for an 11% return, or 54.07% on an annualized basis, so long as the stock stays above 97.50 by expiration. This position also has more than 7% downside protection just in case the stock happens to slide a bit while this trade is open.

Even if the company's earnings don't live up to expectations, if the FDA approves Levadex , which the company clearly expects, it should be enough to send AGN higher.

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