Drug Shares Likely to Rally After Six-Month Slide: Taking Stock
Bloomberg News
June 9, 1999, 4:59 a.m. ET
Drug Shares Likely to Rally After Six-Month Slide: Taking Stock
Paris, June 9 (Bloomberg) -- Olivier Lefevre is scooping up
drug stocks. He's been buying Glaxo Wellcome Plc, SmithKline
Beecham Plc and Pfizer Inc., taking advantage of a slide that
brought Glaxo and Pfizer close to their low for the year.
All told, Lefevre, who helps manage $1.3 billion at Monte
Paschi Banque SA, has doubled the share of his portfolio devoted
to drugs to 15 percent last month. And he's not alone in his
enthusiasm.
''Some stocks are a screaming buy,'' said Nick Turner, an
analyst at Europe Company Ltd. in London. ''We're bound to see
pharmaceuticals come back into play sooner rather than later.''
One reason is self-defense. Drug shares promise steady
profits no matter how well or badly the economy performs.
Economic growth is sluggish in much of Europe and expected to
slow in the U.S.
Another is optimism that takeovers and mergers among drug
companies will push up the stocks. Consolidation is already
underway -- in April, for example, the British drugmaker Zeneca
Group Plc bought Sweden's Astra AB for $40 billion, forming
AstraZeneca Plc, the world's largest drug company.
And, finally, the stocks are cheap. Some have dropped as
much as 20 percent in the past six months. Pfizer has fallen 26
percent since it reached a record 150 1/8 on April 12.
''I bought heaps of Pfizer shares last week,'' Lefevre said.
''At this price, they're irresistible.''
Golden Age
That doesn't mean investors can expect a return of the heady
gains of the past decade, when the Standard & Poor's Drugs Index
outshone the overall S&P 500 by 40 percent. A flow of blockbuster
drugs that powered earnings growth is slowing and customers are
looking to slash costs.
What really pushed drug stocks down this year, though, was a
shift to growth-sensitive stocks. They regained favor as Asian
nations emerged from last year's recessions.
The S&P index, which tracks six U.S. pharmaceutical stocks,
has fallen 11 percent this year. The average stock in the S&P
drug index is now trading at a 10 percent discount to the average
stock in the S&P 500. Since the beginning of the second quarter,
the Dow Jones Europe Stoxx drug index, which follows 14 European
drugmakers, has declined 5 percent.
Even investors and analysts who believe drug stocks aren't
ripe for a turnaround yet say nothing has changed in the industry
enough over the past half year to justify the slump.
''The glass was half full and now it's half empty,'' said
Jeffrey Chaffkin, an analyst with PaineWebber Inc. in New York.
''The fundamentals have not changed.''
Bright Outlook
In fact, many investors say drugmakers' prospects are still
good. An aging worldwide population guarantees demand for pills
to treat ailments ranging from arthritis to heart disease. Slower
growth in Europe and the U.S. will reduce the allure of cyclical
shares. Cost-savings from mergers should enable companies to
funnel more money into research.
For example, AstraZeneca shares have declined almost 18
percent from their April 1 peak. They fell even though the
company plans to save $1.1 billion within three years. It also
sold its specialty chemicals business for a larger-than-expected
$2.1 billion.
Aventis SA, the company to be created in November through
the merger of France's Rhone-Poulenc SA and Germany's Hoechst AG,
will have $3 billion a year to devote to research -- the
industry's biggest budget. That won't guarantee new drugs will be
discovered, but it does improve the chances.
Hoechst and Rhone-Poulenc also share a strategy of shedding
their chemicals units, cyclical businesses that, unlike
pharmaceuticals, tend to suffer when economic growth stalls. The
drug industry is less vulnerable to such swings -- people quit
buying a lot of things when times are hard, but medicine usually
isn't one of them.
Slower Growth
That could be important this year. The Organization for
Economic Cooperation and Development forecasts growth in the 11-
nation euro zone will decline to 2.1 percent this year from 2.9
percent last year. The U.S. economy will grow 2.5 percent to 3
percent this year, subsiding from 3.9 percent in 1998, according
to the Federal Reserve's latest forecast.
''We're still in uncertain times, and I'd stick to growth
stocks like drugs,'' said Michael Krinner, a fund manager at Bank
fur Handel und Effekten in Zurich. Krinner has held on to his
shares of Roche Holding AG and Novartis AG this year, and he says
he may further reduce his stake in more cyclical companies.
While industry analysts and investors are almost unanimous
in saying drug shares will soon reverse their slide, some caution
that industry developments will keep those stocks from matching
the pace of the past decade. The Standard & Poor's drugs index
grew about five-fold over that period, even as the overall S&P
500 index grew 3.5 times.
The Down Side
First, the wave of 1990s blockbusters such as Viagra,
Lilly's schizophrenia drug Zyprexa and Warner-Labert Co.'s
cholesterol-buster Lipitor is slowing to a trickle. Some analysts
say drugmakers' pipeline don't look as promising as they did five
years ago, and patent protection likely will end in a few years
for more than a dozen drugs, including Lilly's antidepressant
Prozac and AstraZeneca's Prilosec, a treatment for heartburn.
Drugmakers may also find it tougher to get some customers to
pay full price. U.S. lawmakers, for example, are talking about
adding a prescription-drug benefit to the Medicare health-
insurance program. That could lead to deep discounts for
medicines the elderly now pay full price for. Managed-care
companies are also starting prescription programs to encourage
people to pay less if they choose a single brand of drugs.
About 40 million elderly and disabled Americans are enrolled
in Medicare, and managed care covers 87 percent of the 150
million workers who get their health coverage through their jobs.
When it comes to pricing power, ''it's a struggling drug
world,'' said John Borzilleri, a pharmaceutical analyst with
State Street Research in Boston.
Getting Older
Still, demographic trends are bound to fuel continued demand
and higher sales volume will help offset price pressures, many
analysts and investors say.
By 2040, the number of European Union residents over 65 will
have doubled compared with those aged 15 to 64, according to the
OECD. In the U.S., the Census Bureau estimates that the number of
people above 65 will rise to 69 million in 2030 from 39 million
in 2010.
Those that stand to benefit the most are drugmakers that
target ailments that afflict an aging population -- as do Pfizer,
Eli Lilly & Co., Merck & Co., and Takeda Chemical Industries Ltd.
of Japan, among others. Pfizer had one of the most successful
U.S. drug introduction ever last year with its impotence pill,
Viagra. Takeda, like SmithKline in the U.K., plans to introduce a
new generation diabetes pill that's expected to snatch market
share away from existing treatments.
Investors and analysts who believe in a drug comeback say
news of another merger, of a larger-than-expected slowdown in
economic growth, or of market concerns may be needed to send
investors scrambling back toward the safety of such shares.
Lefevre of Monte Paschi said he snapped up Glaxo and
SmithKline last week because he anticipates the two companies
could be involved in mergers or acquisitions, either with each
other or with a U.S. rival. The two U.K. drugmakers ended merger
talks last year, suggesting they're both on the lookout for a
partner.
''Another multi-million dollar combination or an economic
slowdown is what's most likely to jolt investors back into buying
drugs,'' said Turner of Europe Company. ''I'm waiting for the
news.''
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