News February 2007

Generic Competitors Restrain Drug Stocks

The past two earnings seasons have served as rallying points for the stocks of big drugmakers, but ongoing cost-cutting strategies and the onus of generic competition have tempered the sector overall.

Over the past three months, the Dow Jones Pharmaceuticals Index, which includes 245 drugmaker stocks, has risen about 4.1 percent. In comparison, indexes of related sectors such as medical equipment and health-care providers have risen 10.2 percent and 13.9 percent, respectively.

Similarly, the Stock Exchange's Pharmaceutical index, which follows 15 major drugmakers, is up about 3.5 percent over the last three months, closing Friday at 354.34.

On the one hand, most drugmakers met or exceeded Wall Street expectations in the third and fourth quarters, sending the Amex index above 362 both times to year-highs, only for the index to stage a retreat both times, even though fairly positive outlooks had been offered.

Part of investors' caution could come from changes in the industry. The sector has seen three new chief executives take the helms of major drugmakers over the past two years. Meanwhile, it has also been challenged by increased generic competition. One recent sign of change was the January cutting of 10,000 jobs from Pfizer Inc., or about 10 percent of the largest drugmaker's work force, as a way of controlling costs and increasing single-digit earnings growth on projected flat revenue.

Also, the success of Democrat-sponsored bills in Congress to give the government the right to negotiate drug prices -- what would amount to a crushing blow for the sector -- remains to be seen.

Deutsche Bank analyst Barbara Ryan called the fourth-quarter for drugmakers "a mixed bag," with some still suffering the blows of new generic competition. For example in 2006, Pfizer lost patent protection for its Zoloft antidepressant, and saw pressure on sales of its best-selling drug, the cholesterol-reducer Lipitor, when cheaper generic versions of a competing cholesterol drug hit the market.

The analyst even pointed to major drug launches in 2006 as proof that new product flow was improving. Pfizer launched Chantix, a drug meant to help people stop smoking, as well as inhalable insulin Exubera and cancer drug Sutent. Merck & Co. launched Gardasil, a vaccine against a virus that can cause cervical cancer, and the diabetes medication Januvia.

However, Pfizer shares have only seen gains of 2.3 percent to $26.21 over the past three months, with Merck shares up 1.4 percent to $43.82 in the same period.

John Boris at Bear Stearns, who has encouraged investors to buy drug stocks by reiterating his "Overweight" rating of the sector, saw a slowdown in the fourth quarter, but projected earnings per share growth of about 10.5 percent for the sector in 2007 versus a Wall Street consensus of 8.9 percent.

The analyst sees revenue improving for the sector in 2007 with an average 5 percent improvement in sales, or a 7 percent average increase factoring out Pfizer numbers. Pfizer stands as the one drugmaker to suffer major patent protection loss in 2007 with allergy medication Zyrtec and blood pressure medicine Norvasc.

Source http://www.businessweek.com/