One Eye on Drug Stocks, the Other on Election Day
By CONRAD DE AENLLE
nytimes.com
A DRUG that helps people lose weight and stop smoking ought to be a big seller, but when Sanofi-Aventis, the French pharmaceutical company, announced success in trials of just such a drug, the company's stock barely budged.
A few days later, in early September, American regulators recommended that AstraZeneca, the British drug maker, not be given permission to market an anticlotting drug, citing safety concerns. There was no muted reaction this time: the stock sank as much as 6 percent the next day.
Shareholders of Merck meted out far worse later in the month. They marked the stock down 27 percent in one day after Merck, based in Whitehouse Station, N.J., said it would halt sales of Vioxx, a top-selling anti-inflammation drug, because of safety concerns.
Investors' tendency to react to negative events and ignore positive ones reflects prolonged adverse sentiment toward drug stocks, which have underperformed the broad market since February. That was around the time that Senator John Kerry consolidated his grip on the Democratic presidential nomination, analysts point out. They note that many investors fear that if Mr. Kerry wins in November, prices of prescription drugs may rise at lower rates than in recent years, or perhaps even decline, dealing a significant blow to drug makers' profitability.
The sector's weakness has reduced the shares of large pharmaceutical companies to prices that analysts and fund managers consider cheap. Many remain leery of buying them, however, and prefer stocks in other segments of health care.
"Without question, large-cap pharma is one of the groups likely to see the most intense regulatory pressure should the presidency change hands," Jami Rubin, an analyst at Morgan Stanley, said in a report on the sector, articulating Wall Street's fears. "The Democratic Party continues to seek greater government involvement in the health care system and is expected to hasten a move toward price controls on prescription drugs if given the political power to do so."
Mr. Rubin finds the market's apprehensions unwarranted. For one thing, Mr. Kerry by no means has a lock on the election; in polls, he has been running at best neck and neck with President Bush. Even if Mr. Kerry wins, Mr. Rubin said, Congress is likely to remain controlled by Republicans, limiting wholesale changes in health care policy.
Nevertheless, the political worries have reduced valuations of American industry leaders. Pfizer and Wyeth have been trading at 15 percent discounts to Standard & Poor's 500-stock index, as was Merck before the recent sell-off. The undervaluation exists "despite our belief that return on invested capital has bottomed out and is likely to show some improvement over the next several years," Mr. Rubin wrote, referring to the pharmaceutical industry.
Gil Knight, senior fund manager at Gartmore Global Investors in Conshohocken, Pa., agrees that valuations are low, but he finds good reasons for them to remain so, no matter who wins the White House.
"I'm not one of those who thinks Kerry's going to destroy the health care system," he said. "A lot of these companies have drugs that are going off patent; the margins are not going to be there." But he said, "Margins would be worse under Kerry than Bush."
Spiros Jamas, a global drug and biotechnology analyst at State Street Global Advisors in Boston, noted that "the pharma industry seems to go through cycles of patent expirations" and that "sales drop significantly and transfer to generic companies."
Still, he said: "The pipeline is improving. There are going to be a number of important drug launches in the next 12 months, which will improve earnings in these companies. Valuations are pretty close to a floor."
An exception he cited is AstraZeneca, which he said he had been avoiding even before the bad news about its anticlotting drug because he saw its shares as too expensive.
State Street holds Sanofi in its portfolios, Mr. Jamas said. Part of its appeal, he said, is the "significant cost savings" achieved through the merger that created the company from Sanofi-Synthélabo and Aventis.
"More important," he said, "the merger creates quite a balanced pipeline, where the company will have a smoothed transition from drugs going off patent to new drugs."
State Street also holds Eli Lilly, based in Indianapolis; GlaxoSmithKline of Britain; and Novartis and Roche, both based in Switzerland. Glaxo has "quite a cluster of patent expirations," he said, but it also has a "broad pipeline" of drugs under development, including treatments for breast cancer and cardiovascular disease.
Mr. Jamas said he liked Lilly because "a fairly high percentage of its drugs are specialty products," including several introduced in the last three years, making this their peak sales period. Highly specialized drugs are preferred because they command higher prices than those that must compete with similar products, he explained.
Niall Kirk, a manager of health care funds at F&C Management in London, is less optimistic than Mr. Jamas about the prospects of large drug makers. He pointed out that drug prices had already come under pressure.
"The numbers that have come out from drug distributors show that price rises are fairly muted now," he said.
"They could be trying to look good before the election" to try to limit government involvement in pricing after November, Mr. Kirk said. Another possibility, he said, is that health maintenance organizations have been unable to raise premiums as much recently as in the more distant past and are driving harder bargains with drug makers.
He and Mr. Knight have mostly left the major drug stocks alone and have put their money to work in related fields like medical instruments and biotechnology.
"We have diversified into other parts of the health care universe," Mr. Kirk said. "We're overweight health care, but we don't do it through Big Pharma."
Mr. Kirk's favorites include C. R. Bard, a Murray Hills, N.J., company that makes tubes and other simple devices used in vascular surgery. In 2001 and 2002, the company was to have been acquired by Tyco International, but when Tyco ran into trouble over accounting and management issues, Bard remained independent. He says Bard is "quite undercovered by the Street."
He also favors Bausch & Lomb of Rochester, the maker of optical equipment and eye care products. Mr. Kirk cited a number of its new products, and said an investment in Bausch & Lomb was also an indirect bet on economic growth. As employment goes up, he said, more people get health insurance, and they take advantage of their coverage to have surgery to correct vision problems.
A biotech stock he likes is Biogen Idec, which he says has a promising treatment for multiple sclerosis coming to market.
Mr. Kirk's portfolios are not devoid of large drug makers. Like State Street, Mr. Kirk owns Novartis and Roche. Offering a less than wholehearted endorsement, he said of the two, "Nothing bad is happening." He also owns Pfizer, a company that he says is well managed and has "a decent pipeline" of drugs under development.
MR. KNIGHT owns an assortment of medical equipment companies, including St. Jude Medical, , a maker of heart valves and other cardiovascular products; Stryker, which makes surgical tools; and Beckman Coulter , a leader in laboratory diagnostic equipment.
Stryker also makes artificial joints, a specialized product line. "It's so unique, there isn't much competition," he said. That gives the company good pricing power.
Two biotechs that Mr. Knight prefers are Amgen and MedImmune. Unlike many others in this industry, which are developing drugs that may someday hit it big, Amgen, based in Thousand Oaks, Calif., is marketing drugs now. "It has real products, with good patent protection," he said.
Its products are successful enough to help it increase its earnings by 20 percent a year, making its stock cheap at about 20 times earnings, Mr. Knight said.
MedImmune, based in Gaithersburg, Md., which makes treatments for immune system disorders, is another fast grower, with earnings rising about 22 percent a year, he said.
Mr. Knight holds one large drug maker, Abbott Laboratories, based in Abbott Park, Ill. But he suggested that Abbott's days in Gartmore's portfolios were numbered.
Abbott is cheap, in his opinion, but he said that was for good reason: its earnings are likely to increase by only 5 percent to 7 percent a year. "It's an elephant type of stock that lumbers along," he said. "There's a defensive nature to Big Pharma. You could probably make the case that the stocks are cheap, but unless they come up with new products, they're not going to give you the kind of growth investors are looking for, so they're not going to pay up for them." |
