Stock Quotes in this Article: BDX, FRX, IDXX, JNJ, MYL

BALTIMORE (Stockpickr) -- It may seem surprising, but investors hate pharmaceutical stocks right now. Or maybe it’s more surprising that harnessing that hate could be a very good thing for buyers this summer.

By and large, investors have been hating on pharmaceutical stocks for the last few years. And they’ve got their reasons: health care reform drama on Capitol Hill, the treacherous cliff of patent expirations, and a market that’s already pretty anxiety-ridden haven’t helped. That’s a big part of the reason why drugmakers boast such big dividend yields right now; they’re being discounted for perceived risk.

But the bets are getting out of control this summer -- that’s why it makes sense to take a contrarian look at the five pharma stocks that everyone hates right now.

With short sellers piling into these five names this summer, shorting is reaching extremes in these big pharmaceutical names, a situation that could lead to a short squeeze.

In case you’re not familiar with the term, a “short squeeze” is the buying frenzy that ensues when a heavily shorted stock starts to look attractive again to investors, causing share price to skyrocket. One of the best indicators of just how high a short-squeezed stock could go is the short interest ratio, which estimates the number of days it would take for short-sellers to cover their positions. The higher the short ratio, the higher the potential profits when the shorts get squeezed.

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    Naturally, these plays aren’t without their blemishes -- there’s a reason (economic or otherwise) that these stocks are being heavily shorted. But for investors looking for exposure to a speculative play with a beefier risk/reward tradeoff, these could be powerful upside plays for the coming year.

    Without further ado, here’s a look at our list of pharmaceutical short squeeze opportunities.

    Johnson & Johnson

    Most retail investors probably don’t think of Johnson & Johnson (JNJ) as a pharmaceutical stock. While popular consumer brands -- like Band Aid and Neutrogena -- may be the extent of most folks’ familiarity with the company, JNJ actually earns close to 40% of its revenue from its pharmaceutical arm. And that’s showing up in the firm’s short interest right now: at last count, Johnson & Johnson’s short interest ratio weighed in at 18.1, meaning that it would take close to a month of buying just for short sellers to cover their bets against this blue chip.

    JNJ is one of the most diversified medical companies in the world, with around 250 subsidiaries that make everything from drugs to medical devices to the consumer products that most people know Johnson & Johnson for. That diversification helps to protect JNJ from the patent drop-off drama that’s been haranguing shares of other drug makers lately.

    While patent exposure is still hefty (around $2 billion in drug sales are set to lose patent protection in the next couple of years), it’s still a small chunk of JNJ’s total business.

    From a financial standpoint, it doesn’t get much better than Johnson & Johnson -- this stock is the prototypical blue chip, after all. The firm’s $17 billion cash position essentially makes it debt-neutral. Even after factoring in the $21 billion purchase of Synthes in 2011, JNJ is in solid shape. With short interest as high as it is, investors should be looking for any upside catalyst to trigger covering.

    Mylan

    Generic pharmaceutical maker Mylan (MYL) is one drug maker stock that doesn’t have the risks of patent expiration to worry about – in fact, it’s set to profit from them. Mylan is one of the biggest generic drug manufacturers in the world, waiting in the wings for popular drugs to fall off the patent cliff before swooping in to make them cheaper than the big pharma companies are willing to.

    Mylan’s size makes it a unique generic play. It has massive global scale, which means that it can take advantage of tailwinds and patent nuances in a bevy of different markets that smaller generics manufacturers can’t.

    The firm has also embraced the more complex biosimilars market (which not all generic drug makers have the skill set to tackle), as well as the branded drugs business with offerings like the EpiPen. The addition of those higher margin businesses to Mylan’s income statement should give MYL the ability to turn out the sort of profitability that other generic drug makers only covet.

    While MYL’s balance sheet isn’t nearly as attractive as JNJ’s, the firm is still in solid financial shape with cash generation easily covering interest expenses. Management’s plan to pay down its debt load bodes well for investors right now. That hasn’t fazed short sellers, though -- with a short interest ratio of 11.4, it would take more than two weeks of buying for shorts to exit their positions at current volume levels. That puts MYL in short squeeze territory.

    Forest Laboratories

    Forest Laboratories (FRX) isn’t your typical pharma firm -- with the company’s big blockbuster anti-depressant Lexapro off patent as of March, FRX has already seen the worst of the patent expiration game this year. But rather than slash at costs in the face of that inevitable revenue drop, Forest has been racking up expenses. It’s been spending money on development of its current pipeline offerings, getting upcoming drug labels up and ready to bring to market. And from where Forest stands, that’s a stellar plan.

    Forest was good with its cash when times were good. One result of that is a balance sheet that boasts $3.2 billion in cash and investment and zero debt. That pile of dry powder gives Forest Labs plenty of wherewithal to keep spending its way to its next drug success, and with a pipeline that’s flush with potential, that’s a very good thing.

    In the mean time, FRX boasts one of the few therapies found useful on Alzheimer’s right now, a drug that should continue to enjoy limited competition as other pharma firms throw in the towel on competing drugs. Other markets that Forest competes in are just ignored by other pharma names, making competition much less of a factor as FRX gets its pipeline ready to bring to market. With a short interest ratio of 10.2, it would take more than two weeks for short sellers to cover their FRX positions.

    Idexx Laboratories

    It’s been a strong year for pet and livestock medical firm Idexx Laboratories (IDXX). While the broad market has earned just over 10% since the first trading day of January, making drugs for Fido has earned the firm’s shareholders 16% returns over that same period. Still, short sellers are betting against Idexx en masse – a short interest ratio of 14.8 means that it would take three weeks for short sellers to cover.

    Idexx is the standard bearer in the veterinary pharmaceuticals market, where the firm offers a combination of diagnostic test kits, lab equipment, and medical instruments for both pets and livestock. While Idexx isn’t exactly a pharmaceutical firm, it’s too close and too good of an opportunity to pass up right now.

    That’s because Idexx harnesses the tailwinds of increased veterinary spending in the last couple of decades as well as the testing-focused nature of the livestock industry in recent years. At the same time, it avoids human health care pitfalls like reimbursements (even pets with health insurance have their owners, not their vets reimbursed) and complex legislation. In the last several years, Idexx has enjoyed solid revenue and income growth as well as a balance sheet that’s rife with liquidity. Shorts are out of line in this animal care stock right now -- and that makes IDXX a real short squeeze opportunity.

    Becton, Dickinson and Company

    Diversified medical device stock Becton, Dickinson and Company (BDX) has exposure to pharma, but its bread and butter is in the business of manufacturing and distributing consumable medical products like needles, syringes, and scalpels. The firm’s exposure to staid (even boring) surgical instruments has given Becton some protection from economic conditions in the past, something that can’t be said for peers who only develop high-tech, hit-or-miss medical devices.

    Becton’s exposure to pharma is centered around delivery systems, such as the syringes that deliver other firms’ drugs. That means that Becton enjoys the tailwinds from increased pharmaceutical usage and an aging population, without caring who’s manufacturing those drugs; big pharma or generic, Becton can still sell its syringes.

    And because Becton is the largest medical device maker of its kind, the firm has already established a robust distribution network that ensures medical facilities across the world have a steady supply of its offerings. Just over half of Becton Dickinson’s business is located overseas. Becton saw steady growth throughout most of the recession, proving the defensiveness of its positioning to investors – a short interest ratio of 10.3 looks overplayed at this point. Any positive catalyst could easily spark a buying frenzy as shorts try to exit their positions.

    To see this week’s short squeezes in action, check out the of of Pharmaceutical Short Squeezes portfolio on Stockpickr.

     

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    -- Written by Jonas Elmerraji in Baltimore.
    At the time of publication, author had no positions in stocks mentioned.
    Jonas Elmerraji, based out of Baltimore, is the editor and portfolio manager of the Rhino Stock Report, a free investment advisory that returned 15% in 2008. He is a contributor to numerous financial outlets, including Forbes and Investopedia, and has been featured in Investor's Business Daily, in Consumer's Digest and on MSNBC.com.