David vs. Goliath: Biotech Frenzy Recedes -- Drug Stocks to Shine
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Director of Online Research: Dave Sterman (3/15/00)
Biotech stocks have pulled back sharply in recent weeks. And for good reason, the shares of outfits large and small were relentlessly bid up in recent months in a massive buying frenzy.
Biogen (NASDAQ: BGEN - Quotes, News, Boards), a biotech bellwether, for example, has slid from $129 to $76.97 since mid-February.
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But these stocks still aren't cheap. The Amex biotech index is still up 228% from year earlier levels, while the Amex drug stock index has fallen 23% since last March.
Amgen looks attractive, as we recently noted, but other leading biotechs look wildly overvalued.
Biogen trades for 59 times trailing earnings. MedImmune (NASDAQ: MEDI - Quotes, News, Boards) goes for 199 times trailing earnings. That seems a bit rich when you consider that drug stocks such as Merck (NYSE: MRK - Quotes, News, Boards), Schering-Plough (NYSE: SGP - Quotes, News, Boards) and Bristol-Myers Squibb (NYSE: BMY - Quotes, News, Boards) trade for 23 to 25 times trailing earnings.
In addition, traditional drug stocks look very cheap on a price-to-sales basis. Merck, Bristol-Myers and Schering-Plough trade for 4.2 to 5.6 times trailing sales. MedImmune and Biogen, in contrast, trade for 36.8 and 23.4 times trailing sales, respectively.
Biotech bulls would be quick to argue that Biogen and MedImmune have much greater growth prospects. That could well be the case for smaller biotechs that are just getting started such as ImClone Systems (NASDAQ: IMCL - Quotes, News, Boards). But the big biotechs are now maturing, and growth rates are slowing in the process.
Biogen, for example, has boosted sales 32% annually over the last five years. But this year, sales growth is expected to slow to 25%, before slowing further to 15% in 2001. And MedImmune's top line growth is expected to slow to less than 20% by next year.
If you really want to quantify growth prospects, you should look at R&D spending, which is a key harbinger for future growth. Biogen spent $225 million on R&D last year and MedImmune spent $40 million, both relatively small amounts. In contrast, Merck, Schering-Plough, and Bristol-Myers spent a combined $5 billion on R&D last year.
Big drug stocks have a proven record of success in key areas. According to ABN AMRO's Marc Booty, traditional pharmaceutical companies have the leading drug in 28 out of 29 sectors he tracks. Only the Multiple Sclerosis market is dominated by a biotech company.
Drug stocks have traded poorly in recent months, thanks in large part to concerns about the upcoming Presidential election. Candidates often like to pick on drug companies while campaigning, only to take little regulatory action once they are elected.
Back in 1992 drug stocks fell 18%, then dropped an additional 6% the following year. The sector went on to rally sharply in subsequent years. Last year, the sector fell 18%, and has fallen another 5% so far this year. You can see a similar pattern emerging.
In the near-term, it may be hard to get excited about the prospects for drug stocks. Key drugs such as Bristol-Myers' Taxol, and Schering-Plough's Claritin will lose patent protection. In addition, profit growth is expected to slow somewhat in the sector, before rebounding in 2001.
But as we move into the second half of the year, investors will set their sights on the longer-term view. And that should help fuel a nice rally for the sector.
As my colleague Bob Hirschfeld noted in a recent piece, Schering-Plough looks to be an attractive play in the sector. After losing almost half its value over the last year, the stock now trades at a 23% discount to the S&P 500. PaineWebber's Jeff Chaffkin, who recently upgraded the stock to Buy from Hold, thinks the company's on track to boost earnings at an above average pace in the second half of the year. The shares should also get support from continuing stock buybacks.
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