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The Case For (and Against) Big Pharma
The Case For (and Against) Big Pharma - Kiplinger.com
Some of the major drug makers' shares look appealing -- but others you might not want to touch with four-foot forceps.
By Bob Frick
May 7, 2008
Big pharma needs a miracle drug. The major drug makers are so beaten down that in some instances dividend yields, rather than the next blockbuster drug in the pipeline, are what are propping up the stocks.
Take Pfizer (symbol PFE). At its May 7 close of $19.92, the stock is off 28% since last June and is 60% below its all-time high, set in 1999. Talk about a lost decade.
The good news, such as it is, is that even as the stock stagnated, Pfizer boosted dividends year in and year out. Result: The shares now yield 6.4%. That's the kind of yield normally associated with a real estate investment trust or a master limited partnership. If not for Pfizer's juicy payout, the stock would almost certainly be lower.
What bugs Pfizer and the likes of Merck (MRK) and Bristol-Myers Squibb (BMY) is a set of ills for which no quick fix exists. One analyst, Credit Suisse's Catherine Arnold, says that patent expirations and a regulatory crackdown are creating a "revolutionary change" in the industry. On the other hand, with drug stocks at historic lows, dividends sweet and an aging population that needs more and better pills, it's fair to ask whether you should be buying drug stocks, despite the litany of woes.
Some experts say yes. But before we let them argue their contrarian case, let's examine the problems in more detail.
Patent cliff. While the companies can finesse some of their problems, they can do little about the biggest one. From 2010 to 2013, sales will take an unprecedented hit as patents on two dozen of the industry's most profitable drugs expire. Falling off this "patent cliff" will be drugs that now account for about 40% of Pfizer's annual sales, expected to exceed $48 billion in 2008. They include the cholesterol-lowering drug Lipitor and the erectile-dysfunction drug Viagara.
Pfizer is hardly alone in its misery. Bristol-Myers Squibb will lose protection on Plavix, a drug used to prevent heart attacks and strokes; GlaxoSmithKline (GSK) will lose asthma treatment Advair; and Eli Lilly (LLY) will relinquish protection on its drug to treat schizophrenia, Zyprexia.
Tough competition. Blockbluster drugs losing patents has always been bad news for drug companies, but today the situation is worse. Manufacturers of generics both here and abroad have become much more aggressive in fighting patents and getting knock-off drugs to market. One study predicts that the generics industry, which already does annual sales of $60 billion, will be able to take aim at an additional $100 billion worth of worldwide drug sales.
High development costs. So, why not just develop new drugs? Easier said than done. To start, that's costly. A widely accepted estimate is that it costs $800 million to develop a new drug, and that figure is rising rapidly. Over the past decade, only about 25 new drugs have come to market each year. However, while the number of drugs-to-market has stayed the same, research and development expenses have doubled.
Tough regulation. And as the costs rise, the Food and Drug Administration has become far more picky about what it will approve. For example, the FDA recently put a roadblock in front of Merck's proposed anti-cholesterol drug, Cordaptive. That didn't help Merck's share price, which, at $39.01, is down by more than one-third since mid January. The FDA has cracked down on all drug approvals since another Merck drug, Vioxx, was suspected of having caused heart attacks in some patients.
Politics. Finally, election-year promises from both sides threaten industry profits. Plans of both Hillary Clinton and Barak Obama include allowing Medicare to negotiate drug prices -- that effectively means regulation of drug prices. And Clinton, Obama and John McCain say they're for permitting re-importation to the U.S. of drugs that carry lower price tags in foreign countries.
All of this adds up to one bleak scenario. And yet, some smart analysts see the sector through Prozac-colored glasses.
Robert Kleinschmidt, manager of the Tocqueville fund, which has outpaced the market every year between 2000 and 2007, says the negatives have pushed the whole sector into such a funk that investors can't see the positives. "The companies have strong cash flows and could have stronger cash flows if they could reduce their largely unproductive research and development expenses," he says.
And you can't underestimate demographics, Kleinschmidt says. While there will be pressure on drug prices, the manufacturers will make it up on volume -- in other words, they'll benefit from the growing number of seniors popping more pills. Moreover, although the populations of developing countries are generally young, their inhabitants will consume more medicines as their nations grow wealthier, says Kleinschmidt.
Big pharma also has something smaller, more innovative drug makers want: Marketing might. George Putnam III, editor of the Turnaround Letter, which has an excellent long-term record, sees a growing number of joint ventures, which will lead to stronger revenues.
And like Kleinschmidt, he thinks drug development problems have been overblown. Says Putnam: "It always seems like they have nothing in the pipeline, and they're doomed. Then they always come up with something."
So confident are Putnam and Keinschmidt in their contrarian view that they both endorse Pfizer, the poster child for Big Pharma's woes. The stock sells at barely more than eight times the $2.36 per share that analysts on average expect the company to earn in 2008.
Essentially, Kleinschmidt and Putnam think that the news on Pfizer is so gloomy that things can only get better. Keinschmidt believes the company will partner with smaller companies to get some new drugs in its pipeline: "You buy it today at $20ish and five years later it's $30ish, and you get a 6% dividend along the way."
Other analysts with a more bearish view of big pharma wouldn't touch Pfizer with four-foot forceps. Zacks analyst Jason Napodano says other beaten-down drug companies have stronger pipelines, better diversification and executives who have been more willing to make tough decisions in recent years. During that time, he says, Pfizer has been "holding hands and singing kumbaya."
One of the few companies Napodano likes in the sector is Johnson & Johnson (JNJ). Only one-fourth of J&J's sales come from pharmaceuticals, with the rest in consumer health care products and medical devices.
But J&J's drug portfolio is broad and isn't flirting with the edge of a patent cliff. Remicade is an anti-arthritis drug that is also being prescribed for everything from psoriasis to Crohn's disease. Remicade sales jumped 37%, to $1 billion, in the first quarter of 2008 from the year-earlier period.
J&J is well managed and has a wonderful track record, says Putnam. "It hasn't stumbled the way some of the other have." At $66.91, the stock sells at 15 times estimated 2008 earnings of $4.45 per share and yields 2.7%.
If J&J is the safe choice to play Big Pharma, Schering-Plough is the one that offers bigger potential rewards, albeit with greater risk. In March, shares of Schering (SGP), along with those of partner Merck, took hits when a study showed that Vytorin, a joint-venture medicine to keep arteries clear from plaque, was no more effective than a generic. Schering, which had traded at $33 last October, dropped to less than $14, but has since recovered to $18.18.
Vytorin is the bad news. The good news is that generics won't be eating Schering's lunch anytime soon. Of all the major drug companies, Schering is least vulnerable to competition from generics manufacturers, says Caris & Company analyst David Moskowitz. He adds that, FDA willing, Schering will win approval for two products this year and has 11 chemicals in advanced trials.
The company has also promised a restructuring plan that will slash $1.5 billion in costs by 2012. And a quick look at the top line of the company's income statement show healthy momentum. Its sales have grown about $1 billion over the past three years. In 2007, Schering bought Organon BioSciences, a Dutch biotech firm, for $14.4 billion, which is one reason for its fat pipeline. Analysts predict that Schering will earn $1.53 a share this year and $1.71 in 2009.
That comes to a dirt cheap 12 times 2008 earnings. If the cloud ever rises from the pharmaceutical industry, expect Schering's stock price to rise the quickest. But even if the industry stays on the ropes, Schering's stellar profit growth will be all the tonic its stock needs.
Healthcare Cash Crisis Will Hit Drugmakers -Report
LONDON -(Dow Jones)- A looming cash crisis in global healthcare systems threatens to seriously disrupt drug companies' research into new drugs, pipelines, and pricing, a new report will warn this month.
At the end of May, global management consultancy AT Kearney is to publish a paper, Healthcare Out Of Balance, warning healthcare systems in developed nations, including the U.S., U.K. and Europe, are simply not sustainable as it is becoming increasingly hard to fund expensive treatments for aging populations.
Healthcare is a $4.5 trillion a year industry and consumes 10% of global gross domestic product. Spending on healthcare is forecast to rise at 4% a year, but as the populations of developed nations get older there will be fewer people of working age to pay for it through taxes or insurance premiums, the report will say.
AT Kearney U.K. health practice leader and author of the report Jonathan Anscombe told a London seminar Monday that today's healthcare systems were designed for the postwar "baby-boomer" generation, when there where typically six or seven working people for everyone in retirement. That will have dwindled to about three by 2020, he said.
Anscombe said in response future healthcare spending is likely to focus on a few "core services", like prevention and managing chronic illnesses. Expensive, biologic drugs that extend the lives of cancer patients - which dominate drug makers' current pipelines - will not be included, potentially harming future sales.
As healthcare spending in developing nations like Brazil, Russia, India and China rises, drug companies will shift their focus to the diseases of the developing world like malaria, tuberculosis and HIV, Anscombe said. GlaxoSmithKline PLC (GSK.LN) has already started down this road, he said.
He added differential pricing -where drugs cost less in poorer countries - will become the norm and health systems will demand more "risk-sharing" deals like that struck between the U.K.'s NHS and Johnson & Johnson (JNJ), which has agreed to reimburse the NHS for every patient who fails to respond to the cancer drug Velcade, he said.
And Anscombe said the big risk is that if revenue from the U.S. market starts to fall it won't be made up for by sales in developing markets - potentially disrupting the "innovation cycle" that depends on this cash for the development of new drugs.
Company Web site: AT Kearney Home Page
-By Jason Douglas, Dow Jones Newswires; 44-20-7842-9272; jason.douglas@ dowjones.com
Very nice articles. I think anything healthcare is such a crapshoot, in a crapshoot game.
Its bad enough trying to find good companies in the other sectors. In this sector it relies on not one, but two constantly changing entities of the Governments judgements. Whether it be a yay or nay in front of the FDA or whatever direction the political health insurance winds are blowing.
I give you credit though you certainly have some big stones to play this game.
it's true there are a lot of variables, but I think most of the downside is already priced in
big pharma is trading at very low multiples now, and the dividend yields are awesome
with an aging population and a lot of health-care expansion in developing countries, I think there is a lot of room to grow
definitely some concern stateside, but these copanies have plenty of other people to sell to. Asia comes to mind.
Record venture capital and heated deal environment propel global biotechnology industry forward in 2007 - FierceBiotech
Ernst & Young's 2008 Global Biotechnology Report reveals robust investment in the industry; sweeping trends that are transforming the industry
Boston, 20 May 2008 - The global biotechnology industry achieved record levels in financing and deal making in 2007, as investors and strategic partners showed strong confidence in the sector amid tightening global financial conditions that will continue to test the industry in 2008. These and other findings were highlighted in "Beyond Borders: Global Biotechnology Report 2008", Ernst & Young's annual report on the trends shaping the biotechnology industry, released today.
"In 2007, investors were drawn to the tremendous value of biotech's innovation, with impressive results, as venture financing and deal making reached unprecedented heights," said Glen Giovannetti, Ernst & Young's Global Biotechnology Leader. "To continue its multi-year track record of progress, the industry must meet the current challenges of cooling public equity markets, greater regulatory scrutiny and higher product approval and reimbursement hurdles with fiscal discipline and the creativity and innovation for which it is known."
Key industry findings described in the report include:
> The global biotechnology industry had a very strong year on the financing front. Companies in the Americas and Europe raised more than US$29.9 billion - a new high excluding the outlier genomics bubble year of 2000.
> Venture financing reached an all-time high in 2007 with investment totaling about US$7.5 billion, fueled by a record total of US$5.5 billion in the US and 72% growth in Canada.
> Global public biotechnology company revenue rose by 8% in 2007, crossing the US$80 billion threshold for the first time.
> Absent the acquisition of several leading biotech revenue producers by big pharma, revenue would have increased by about 17% - in line with the industry's historical compound annual growth rate.
> The global industry's net loss decreased from US$7.4 billion in 2006 to US$2.7 billion in 2007. In the US, the industry came closer to aggregate profitability than in any previous year.
> Deal making reached new heights in 2007. In the US, the total potential value of deals announced during the year - including mergers, acquisitions and strategic alliances - was close to US$60 billion, outdistancing all other years by a wide margin. In Europe, the total potential value of such deals skyrocketed to about US$34 billion.
Commenting on the state of the European biotech sector, Jürg Zürcher, Ernst & Young's Biotechnology Leader for Switzerland and Central Europe said, "Today's European biotech industry is vastly stronger than it was just a few short years ago, with firms able to draw strategic buyers in droves and achieving remarkable growth in deal values, thanks to their maturing pipelines and rise in product approvals. As the industry faces a more difficult financing environment ahead, it will need to build on its enduring strength by translating its maturing pipeline into marketed products over the next couple of years."
While industry performance was strong on several fronts in 2007, emerging challenges have made the road ahead more difficult for many biotech companies. In the US, product approvals slowed, as safety concerns related to new and already approved products increased, and the US Food and Drug Administration (FDA) faced resource constraints. In the UK, growing pricing pressures brought the first-ever agreement by a company to refund a payor for the cost of treating patients that do not respond to its medication. In China, safety issues prompted a determined regulatory response. Meanwhile, the industry faces more stringent enforcement of numerous regulations - from sales and marketing rules to the US Foreign Corrupt Practices Act.
New rules for a changing game: sweeping industry changes ahead
The "Beyond Borders" report examines three key trends that are transforming business models and the nature of competition for biotechnology and pharmaceutical companies.
Reinventing big pharma:
As they face unprecedented patent expirations, pharma companies are trying to boost earnings by cutting costs and making deals. But the report points out that these approaches can only buy so much time - longer term, pharma companies need to fundamentally reinvent their structures and incentives to improve the productivity of their innovation efforts. For biotech firms, the opportunity is to work collaboratively with big pharma, using creative business models that give them increased flexibility and a larger share of the value they help create.
The rise of personalized medicine:
The adoption of personalized medicine is being hastened by business drivers such as pricing pressures and safety concerns. The Beyond Borders report predicts that personalized medicine will fundamentally alter the competitive landscape, changing the bargaining power of small and big drug companies and forcing firms to reassess traditional sources of competitive advantage.
Similar to personalized medicine, globalization is radically altering the traditional competitive advantages of pharma and biotech companies. While the initial focus has been to lower drug development costs, these financial gains will be temporary, according to the report. The real opportunity is for western companies to work with partners in emerging markets to develop innovative products suited specifically for local market conditions.
Key regional findings
Revenues of public biotechnology companies in the US rose over 11% from US$58.6 billion in 2006 to US$65.2 billion in 2007.
The US industry's aggregate net loss was under US$300 billion - less than 0.5% of revenues and the closest it has come to overall profitability in its history.
The US industry raised an all-time high of US$5.5 billion in venture capital, about US$2 billion more than the previous record.
Approvals by the US Food and Drug Administration (FDA) for both pharmaceuticals and biologics slid precipitously in 2007, with the lowest number of new molecular entity (NME) approvals in over two decades.
The European industry's revenues declined in 2007 because of the loss of publicly listed biotech giant Serono, which was acquired by Merck KGaA. Without this acquisition, public companies revenue growth would have been 20%. After years of lackluster growth, the European sector is sustaining robust financial performance.
The industry raised a total of €5.5 billion, an increase of 18% from €4.6 billion in 2006.
The number of products in the clinical pipeline - including those in preclinical and clinical development - increased by 9%, climbing to 1,712 in 2007 from 1,576 in 2006.
Asia-Pacific biotechnology industry revenues grew by 21% and net loss declined by 98%, causing the industry to essentially break even. The strong performance was driven by the Australian sector, where the largest firm, CSL, had a very strong year.
There was a marked increase in IPOs, which brought in more than US$750 million. Eight companies went public in Australia and five Chinese companies listed on US exchanges.
About Ernst & Young's Global Biotechnology Center
Today's rapidly changing biotechnology industry is delivering new levels of health, prosperity and sustainability. But it is also facing unprecedented challenges. Ernst & Young's Global Biotechnology Center brings together a worldwide team of professionals to help you achieve your potential - a team with deep technical experience in providing assurance, tax, transaction and advisory services. The Center works to anticipate market trends, identify the implications and develop points of view on relevant industry issues. Ultimately it enables us to help you meet your goals and compete more effectively. It's how Ernst & Young makes a difference.
About Ernst & Young
Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 130,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve potential.
For more information, please visit Ernst & Young - Global Home.
Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.
This news release has been issued by EYGM Limited, a member of the global Ernst & Young organization that also does not provide any services to clients
The Trouble With Merck: One Analyst Turns Sour
By Ed Silverman // September 10th, 2008 // 10:06 am
There are at least four - count ‘em, four - issues that are plaguing Merck and prompting Sanford Bernstein analyst Tim Anderson to downgrade the shares. In an investor note this morning, he writes the stock has already hit his $36 price target and has little upside. Why? Let’s see…
Reasons To Be Doubtful, Number One: The Singular allergy med. Prescription trends are lagging, there is an ongoing FDA safety review that could report out at year’s end (look here), and the potential that Teva does an ‘at risk launch of a generic next year;
Reasons To Be Doubtful, Number Two: Sales trends for the Gardasil HPV vaccine have been weak for the last few quarters in the three territories reported by Merck (background here and here.
Reasons To Be Doubtful, Number Three: The lack of a meaningful pipeline, with at least one Phase 3 drug - taranabant for obesity - likely to not see the light of day. Why? Psychiatric side effects (back story);
Reasons To Be Doubtful, Number Four: The “jolt” to Vytorin and Zetia from Enhance trial data earlier in the year and the more recent SEAS trial data “only compounds the situation,” he writes.
“Over the longer-term, given the slow-down in various franchises along with the scheduled expiration of several big products through 2012, the biggest being Singulair in 2012, Merck’s growth profile appears lackluster.
“The consensus view – and probably the correct one - is that Merck has “best in class” R&D capabilities, meaning they should have the best “optionality” for new product flow in future years, but the visibility on this today is low.
“When Merck reported second quarter results, it suspended guidance, claiming that the recent SEAS data with Vytorin caused too much uncertainty. We think it was probably more than just SEAS led to MRK’s actions…
“Perhaps the most meaningful catalyst through the end of the year will be Merck’s December analyst meeting where the company will give an R&D update. Merck has previously pulled rabbits out of hats when it comes to products advancing to Phase 3. If history is any predictor, the stock will rise as the meeting draws closer, and performance from there will depend on what R&D surprises emerge (or don’t).”
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