Stock of the Day
Mar 02, 2000
Schering-Plough: Cheapest of the Cheap?
Concern about Medicare reform and patent expirations have drug stocks very depressed. Investors looking at these stocks needn't be depressed, though, indeed many analysts are upbeat about the long-term prospects for this sector due to the combination of a solid growth outlook and value at these depressed levels. Schering-Plough (NYSE:SGP - news) is one of the "cheapest" stocks on a Price/Earnings basis among the major pharmaceuticals. While there are some obvious reasons for its recent weakness, analysts at Bear Stearns upgraded the stock to a Buy rating this week due to its low valuation and prospects for its drug pipeline.
Schering-Plough is heavily dependent on Claritin, the allergy drug which accounts for around 30% of its $9 billion in revenues. The competition for Claritin got tougher this week when the FDA formally approved a once-daily dose of Allegra, the antihistamine from Aventis (NYSE:AVE - news) that was previously available only in a twice-daily dosage. Most experts don't see the competition causing an outright decline in Claritin sales, but it will limit future growth.
As if that's not enough, patent expirations on Claritin have added to investor concern and confusion. The stakes are high simply because it is such a big seller ($2.7 billion last year), but there are also an unusual number of extreme variations in the potential outcome. As things stand now, Claritin is presumed to lose part of its patent protection in 2002, though some generic drug makers are challenging it now in the hopes of hitting the market with cheaper versions. Most analysts are confident that the basic formulation of Claritin will maintain exclusivity until 2002, and some of the other five formulations such as 24-hour Claritin-D (which adds a decongestant to the antihistamine) have protection until 2012.
The company is also working on other variations including a metabolite version which it licensed from Sepracor. That product could gain FDA marketing clearance this year and have patent protection up to 2014. Assuming that the drug reaches the market as planned, the key would be for SGP to convert as many Claritin users as possible to this "new and improved" version before the 2002 expiration, extending the franchise another decade.
SGP increased its revenues 19% and earnings per share by 21% in 1999, with 16%-17% growth expected by analysts in the next two years. For a company of this size, that's pretty impressive growth. Schering-Plough has worked hard to protect and extend its Claritin franchise, but it is also building a stable of other products to carry the load and sustain its double-digit growth rate.
Schering-Plough has products in several treatment areas including anti-infective/anti-cancers, cardiovasculars, dermatology, animal health and consumer health products (Dr. Scholl's and Coppertone). SGP is counting on continued strength in its anticancer and Hepatitis C treatments, Intron A and Rebetron. These products sold over $1 billion in 1999 and may ultimately be worth $2 billion as improved versions come through the pipeline.
But the respiratory group is far and away the key engine for this freight train. In addition to Claritin, the company has Nasonex, a corticosteroid nasal spray for hay fever which sold $125 million in its first year on the market. This year Nasonex is expected to sell over $400 million and it could approach $600 million next year. The company adds another new product to this group for 2000, Asmanex, a steroid treatment for asthma.
Beyond the company-specific issues, pharmaceutical stocks are struggling of late with rising interest rates and worries about Medicare reform that could alter the market for pharmaceuticals. While drug cost controls appear unlikely, the uncertainty on this front is likely to persist through the 2000 election year. Several industry analysts have pointed out, however, that the impact of a worst-case scenario for Medicare reform is more than priced in now.
SGP is trading near its 52-week low of $33.38, or less than 22 times expected earnings for 2000. While that is a slight premium to its growth rate, it is a discount to the S&P 500 P/E of 27. Drug stocks as a group traditionally trade at a premium to the S&P 500 of around 25% on average, but they are currently near parity as a group. So as Bear Stearns pointed out this week, of all the depressed valuations in the drug sector Schering-Plough really stands out as one of the worst cases.
The company is also buying back its own shares in what amounts to a statement by its management that they have confidence in their growth prospects and believe their stock is a good value at these depressed levels. Schering-Plough said it expects to complete a previously-announced $1 billion buyback this quarter and would consider launching a new one.
For investors to follow the lead of Schering-Plough's management will probably require several uncertainties to be reconciled. The Medicare reform issue should be cleared up one way or another this year with the election, while Claritin's competitive and patent positions should be clarified in the next year or two as well.
- James Hale
The Online Investor |
