Booster shot for your portfolio?
Prices of pharmaceutical stocks have fallen in the last several
months. Many analysts now prescribe a healthy dose for the
individual investor.
By Andrea Ahles
INQUIRER STAFF WRITER
May 18, 1999
The heady days of pharmaceutical stocks are history - at least
temporarily.
Many pharmaceutical companies are trading about 25 percent lower than
they were in late 1998 and early 1999. Concerns about Medicare price
controls and forthcoming patent expirations on blockbuster drugs have
pushed the drug sector out of favor on Wall Street.
To this decline in stock prices, many analysts have a one-word response:
"Buy." They are prescribing a healthy dose of drug stocks for the
individual investor.
Drug giant Merck & Co. is considered a bargain by analysts at $71.94 a
share, and Viagra's manufacturer, Pfizer Inc., is trading at $114.63 a
share, well below its high of $150.13 on April 12. But the stocks
probably won't drop much lower, experts said.
"Pharmaceutical companies have done very well in the past three or four
years, and now with the stocks slightly lower, this is a good buying
opportunity for long-term investors," said Sergio Traversa, an analyst at
Mehta Partners in New York.
Philadelphia-area investors, however, because of the heavy presence of
the industry in the region, need to make sure they don't become - or are
not already - overweighted in pharmaceutical stocks, a local broker
recommended.
Analysts attribute the decrease in drug-stock prices to a shift in investor
sentiment from pharmaceutical companies to cyclical industries, such as
manufacturing, which are expected to gain value as economic conditions
in global markets improve.
Also, there was a large sell-off following the February introduction of a
congressional bill that would make prescription drugs available to
Medicare recipients at a discounted price.
Change in Medicare's drug policy will not happen overnight - the bill is
still in committee - and probably will not affect pharmaceutical companies
in the near future, said Jason Kolbert, an analyst at Salomon Smith
Barney in New York.
What makes pharmaceuticals good investments is that manufacturers
consistently report positive net earnings and pay substantial dividends,
Kolbert said. With an aging U.S. population, drug sales are expected to
rise, and pharmaceutical earnings should remain strong, he said.
Since 1991, the duration of the Food and Drug Administration's
drug-approval process has dropped from two years to approximately
one, which has sped up the drug-development process. Faster approval
gives pharmaceutical companies extra time to market and sell a drug
before its patent expires, Traversa said.
Also, the industry is going through a consolidation period, giving investors
the chance to benefit from possible mergers and acquisitions, said Carl
Gordon, an analyst at OrbiMed Advisors in New York.
"There is more and more pressure on the smaller [drug] companies to
merge or be acquired so they can gain a worldwide marketing
organization," Gordon said. Often, pharmaceutical companies are unable
to market a drug they have developed without the help of a larger
company with a large sales network.
Swedish pharmaceutical company Astra AB, for instance, formed a
partnership in 1982 with Merck to market Astra's drugs in the United
States. The partnership led to a jointly owned company called
AstraMerck, which developed the popular ulcer drug Prilosec. The
company disbanded in June 1998; Astra has since merged with Zeneca
Group Plc of London.
But Gordon said no one knows which company will be next in this merger
activity and advised against buying a drug stock because of a merger
rumor.
Last month, Johnson & Johnson was rumored to be acquiring Malvern
biotechnology company Centocor Inc. Reports of talks between the
companies pushed Centocor stock up from $35 to $49 in a few days.
Last week, as news accounts said the talks were off, Centocor stock
plummeted more than 10 percent Wednesday.
Instead of looking for the next takeover target, investors should consider
a combination of small and large drug stocks, experts said. Drug stocks
should represent approximately 11 percent of an individual investor's
portfolio, said Bill McLaughlin, vice president of investments at Salomon
Smith Barney's Philadelphia office.
Because many people in the Philadelphia area work for pharmaceutical
companies, many individuals already own drug stocks that they have
either inherited or bought through employment incentive programs. So
McLaughlin recommends that these investors look at other industries to
balance their portfolios.
Investors often ask about pharmaceutical companies that have newly
approved drugs. When Viagra was launched last April, Pfizer was the
stock investors asked for, McLaughlin said.
Investors also ask about drug companies with established reputations, he
said. "Merck is regarded as one of the better-run drug companies and
oftentimes that is a stock people will seek out," McLaughlin said.
But like other pharmaceutical companies, Merck today is facing a
short-term financial crisis because of U.S. patent expirations. Patents on
four of its top-selling drugs - Vasotec, Pepcid, Prilosec and Mevacor -
will expire in 2000 and 2001.
According to a Boston Consulting Group study, patents on 25
brand-name drugs that accounted for $26 billion, or 29 percent, of 1997
worldwide pharmaceutical sales, are set to expire between 2000 and
2002. Though the patent issue has discouraged some investors, analysts
said the problem is company-specific and not a sign of an industry
downturn. None of Pfizer's leading drugs, for example, have patents that
expire before 2002.
Some drug companies are trying to find a way around the patent issue
through advances in chemistry and genetics.
Eli Lilly & Co. - which manufactures the antidepressant Prozac, with a
patent expiration in 2001 - is developing a new compound that is slightly
different from Prozac on the atomic level but is expected to work as well
as the existing drug. If successful, Lilly would be able to patent the new
compound and exclusively sell its new and improved version of Prozac.
The advances are revolutionizing drug research. Drug development in the
laboratory that used to take 10 years now takes five, says the
Pharmaceutical Research and Manufacturers Association, a trade group
in Washington.
Also, more compounds are being tested, leading to more drug launches
than ever, said David Saks, managing director of Gruntal & Co., an
investment research firm in New York. These changes should lead to
greater profit margins, he said.
While there are issues that may affect pharmaceutical companies'
short-term earnings, Saks said he is bullish about the industry's long-term
outlook.
"Innovation," Saks said, "is driving the sales and the earnings at an
unprecedented high rate that will continue for many years."
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