Drug Shares Still Have Only Higher to Climb: Taking Stock
Bloomberg News
October 28, 1998, 3:38 p.m. ET
Drug Shares Still Have Only Higher to Climb: Taking Stock
New York, Oct. 28 (Bloomberg) -- Drug shares are expensive.
They've always been expensive. They'll stay expensive. But
they're still a good buy.
Pfizer Inc., Merck & Co. and their rivals outperformed the
broader market when it was headed higher, and when it fell
earlier this year. Now, they're poised to outperform as the
economy slows.
The Standard & Poor's Drugs Index -- which includes Merck,
Pfizer, Eli Lilly & Co., Schering-Plough Corp. and Pharmacia &
Upjohn Inc. -- returned 32 percent this year. The Standard &
Poor's 500 Index returned just 10 percent, after dipping to a 14
percent loss in late August, as investors drove down stock prices
amid concern earnings growth was slowing.
''The real big concern with the marketplace is a recession''
or slowdown in the economy, said Frank Sustersic, a money manager
at Turner Investment Partners Inc., which manages $3 billion.
Pharmaceutical issues ''historically have always outperformed the
broader market,'' under those circumstances. ''Most
pharmaceutical usage is non-discretionary.'' Sustersic owns
shares of Warner-Lambert Co. and Schering-Plough.
Regardless of what the economy's doing, drug companies
benefit from an aging population and a steady stream of new
products, such as Pfizer's impotence treatment Viagra, investors
say. Also, a faster drug approval process means more products on
the market, and companies can charge higher prices because there
is little competition for some star drugs.
Companies are counting on blockbuster sales for new drugs
such as Monsanto Co.'s painkiller Celebra, to be marketed by
Pfizer's sales force.
Long-Term Prospects
Even investors who sold some of their drug shares this year
say pharmaceuticals are a great long-term investment. ''The
average number of prescriptions per person in America is 12 per
year, up from eight in 1990 and rising as our population is
aging,'' said Lynn Yturri, the manager of the $850 million One
Group Income Equity Fund. ''As you age, you go on these
prescription things for the rest of your life.''
He pared his holdings of Warner-Lambert Co. and American
Home Products Corp. this year because they no longer yield enough
in dividends, though he still owns shares of both.
There are those investors who are avoiding the stocks
because their prices are high relative to their expected
earnings.
Pfizer, for example, sells for 42 times its expected 1999
earnings per share, while Merck, the largest drugmaker, sells for
27 times. The S&P 500, in contrast sells for 22 times, using
First Call's consensus forecast for operating earnings.
''I'm not saying (drugmakers) will come down tremendously.
I'm saying they will become relative underperformers,'' said Phil
Schettewi, who oversees $4 billion as chief of the Washington
office of Loomis Sayles & Co. Schettewi doesn't hold any large
drugmakers in his portfolio.
Many analysts warn against predicting that drug stocks will
fare worse than the rest of the market just because price-to-
earnings multiples are high.
''For two years, people felt the multiples were too high and
they've gone higher,'' said Jami Rubin, a drug stock analyst at
Schroder & Co., who has ''outperform'' ratings on Pfizer, Bristol-
Myers Squibb Co., Warner-Lambert, Pharmacia & Upjohn and
Smithkline Beecham plc.
Earnings
Investors are willing to pay relatively rich prices because
pharmaceutical companies are better earners than companies in
other businesses.
Eli Lilly, which trades at about 34 times next year's
estimated earnings, this month said third-quarter earnings per
share jumped 33 percent on increased sales of its schizophrenia
drug Zyprexa and antidepressant Prozac. Pfizer's profit rose 13
percent, Merck's gained 15 percent, Schering-Plough posted a 21
percent gain for the most recent quarter and Warner-Lambert saw a
46 percent surge.
Earnings from operations for the S&P 500 overall, by
contrast, are expected to drop about 3.2 percent, and analysts
are busily trimming their growth forecasts for the fourth quarter
and next year.
With high expectations come brief disappointments. Pfizer
shares fell 5.9 percent Oct. 13 after the company said it earned
51 cents a share, less than the 57 cents expected by analysts.
The unprecedented early demand for Viagra when it was
introduced in the second quarter may have prompted some analysts
to raise expectations too high for the third quarter. Pfizer sold
$411 million of the impotence drug in the second quarter and only
$141 million in the third, below the $150 million to $200 million
target of some analysts. Also, Pfizer had a higher tax rate than
last year and it boosted sales and research spending to push new
products such as Celebra, analysts and investors said.
That's money well spent, Pfizer bulls say. The stock jumped
9.7 percent the next day and is up 21 percent since the profit
report.
''You could quarrel with the valuation, but as far as the
quality of earnings and the outlook for the company, I don't
think there's any argument that this company is a leader,'' said
Trent May, manager of the $820 million Invesco Growth Fund, who
owns Pfizer shares.
--Phil Serafino in the New York newsroom (212) 318-2358 with |
