SmartMoney Online: Hooked on Drugs
September 22, 1998 8:12 AM
By Suzanne Oliver
NEW YORK (Dow Jones)--Are drug stocks the
perfect cure for ailing portfolios? Obviously lots of
investors think so. Because even as health care
subsectors like long-term care (down 22.5%
year-to-date), hospital management (-19.9%) and
managed care (-17%) are ushered to the terminal ward,
drug stocks are posting all-time highs. The sector has
climbed 27.7% so far this year. And individual stocks
like Warner Lambert (WLA), up 74.8%, and Schering
Plough (SGP), up 35.1%, have done much better.
But is the performance warranted? Warner Lambert is
now trading at 50 times 1998 earnings. Schering
Plough's 1998 P/E multiple is 42 - more than twice that
of the S&P 500. Can these stocks possibly go any
higher? We put that question to Richard England,
manager of Putnam Health Sciences (PHSTX), one of
our three A-rated health care funds. (We created our list
of A-rated health care funds using our enhanced Fund
Finder, Version 2.0, which allows riteria including sector
and SmartMoney grade.) England, 39, has been
managing Health Sciences for just a year and a half,
though he has worked at Putnam since 1992. And he
has studied drug stock performance going back further
than that. "Pharmaceutical fundamentals are as good as
they've been in decades," he explains. 'They've got lots
of new products, a compliant, quick FDA, increased
R&D spending (even as a proportion of sales) and little
exposure to the emerging markets." England proce eds,
'There's more certainty here than in any other group out
there." And that explains why drug stocks are soaring.
Investors, worried about earnings in almost every other
sector, are flocking to pharmaceuticals, where retail
spending is expected to increase 15% this year,
according to the National Association of Chain Drug
Stores. "Managed care turned out to be good for
drugs," says England. "Before, people had to pay for
their own drugs until they'd met their deductible. Now,
they have just a $5 co pay, so they are willing to
medicate." In addition, more seniors are now joining
HMOs, where they generally get drug benefits they did
not receive under regular Medicare.
As a result of that increased demand, unit sales for drugs
are expected to grow at a 5% rate from now until 2005.
Add the impact of price increases and more
higher-priced sales and you get average revenue growth
that's greater than 10%. "There aren't many industries
where you get that kind of growth," says England.
Some stocks in the industry will give you growth at many
times that rate.
Take Warner Lambert, England's second-largest
holding. Last year, the company launched its
blockbuster cholesterol-lowering drug, Lipitor, which is
likely to reach $2.4 billion in sales in 1998. England
expects the company's earnings per share to climb 45%
this year, 35% in 1999 and 25% for the near-term after
that. That explains Warner Lambert's nose-bleed P/E
multiple. But, is the stock still a buy? Says England, "I'm
not going to put on a straight face and say Warner
Lambert's cheap. But you tell me what you want to buy
when everything else is blowing up." Indeed, earlier this
year England substantially reduced his holdings of
troubled HMO and nursing home stocks and added to
his positions in drug stocks. "I still view them as having
room to go. Their relative P/Es are just a little above
middle range. In fact, they traded at higher multiples
back in the 1970s," he says. Two positions England
increased are American Home Products (AHP) and
Merck (MRK), both of which he expects soon to
introduce billion dollar drugs. Later this year, AHP's
Searle unit is expected to launch Celebra, a Cox-II type
drug for fighting osteo and rheumatoid arthritis. (Pfizer
(PFE), another portfolio holding, is a marketing partner
for both Celebra and Lipitor.) Merck's Vioxx, a similar
drug, is expected to be introduced in the spring or
summer of 1998.
Still, perhaps as a hedge against those high P/E drug
stocks, England also accumulated new positions in
cardiovascular device makers Boston Scientific (BSX)
and Guidant Corp. (GDT) and in the restructuring
hospital chain Columbia Health Care (COL) this year.
Says England, "We visited Columbia and saw they'd
made substantial progress. We thought a resolution with
the government was imminent, and wouldn't cost as
much as the bears expect. It's a defensive stock, with no
overseas exposure." But, adds England, "It's
underperformed since we bought it, which is
disappointing.' Indeed, the stock is down 22 .4%
year-to-date, and the government investigation of billing
fraud at Columbia lingers on. Still, England is confident
the company will soon see its earnings growth rise to a
rate in the low-double digits. The stock is trading at 18
times expected 1998 earnings.
Meanwhile, England is keeping half of his portfolio in the
ever-soaring drug sector. "The only time these stocks
underperform is when their earnings growth lags the
market,' he explains. "That happens when the economy
is coming out of a rece ssion and everything else is
roaring up." Until then, says England, drug stocks are a
relatively safe haven. Even at 50 times earnings.
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