Big Pharma: What Safe Haven?

Tag : alternative health products

Unfounded Reputation for Stability?
The drug industry's safe-haven status is coming into question, aseven the most basic assumptions about its stability are provinguntrue. In the second quarter, the number of prescriptions fell forthe first time since the mid-1990s. Polls show that because ofrising health-care costs, patients are more apt to skip doses orcut their pills than they were three years ago. And nearlyone-quarter of patients report not filling a prescription becauseof expenses, says the Henry J. Kaiser Family Foundation.
Add in the long-term threats to the industry, and it starts tolook as if cash or perhaps U.S. Treasuries might be a saferinvestment than drugs. Some of the biggest industry names arefacing daunting patent expirations. Pfizer (PFE) will lose its $13billion-a-year cholesterol blockbuster, Lipitor, to genericcompetition in 2011. Bristol-Myers Squibb's (BMY) powerhouse bloodthinner Plavix, with $5 billion in sales, goes off patent that sameyear. Merck already lost patent protection for its $3 billionosteoporosis drug, Fosamax, earlier this year.
Drug companies are trying desperately to come up with substitutesfor these big products, but even there, Big Pharma is struggling.Part of the problem is that the Food & Drug Administration hasbecome increasingly picky and cautious. The federal regulator hasbeen rejecting more drugs because of safety concerns or a lack ofcompelling evidence that they represent a true advance over what'salready available. In April, Merck suffered two FDA rejections inthree days, including one for a cholesterol drug that analysts hadpredicted would be a blockbuster. "In terms of generic exposure andthe success of the pipeline, it doesn't look great," says HermanSaftlas, a pharmaceutical analyst for Standard & Poor's, which,like BusinessWeek, is owned by The McGraw-Hill Companies (MHP).
Cost-Cutting: Not a Long-Term Fix
History shows that even the dividend isn't sacred in thisindustry. In 2003, Schering-Plough CEO Fred Hassan slashed thecompany's dividend to 22% a share from 64% as part of a turnaroundstrategy. [The dividend is now 26% a share.] Investors were nonetoo happy, and those who have stuck with Hassan have been on asickening roller-coaster ride. Their shares returned nearly 60% bymid-2007, but then went into a free fall earlier this year, when astudy suggested Schering's cholesterol drug Vytorin may be no moreeffective than cheaper alternatives.
Prior to the recent second round of bad Vytorin news, Schering hadbeen rebounding partly on the success of Hassan's cost-cuttinginitiatives. Most pharmaceutical companies have spent the last fewyears slashing sales personnel and implementing efficiency plans toprop up earnings. But there's only so much cutting they can do;slimming efforts may only benefit shareholders in the short term.
Safety in Diversity
Is anything in this sector truly safe? Analysts recommendcompanies such as Johnson & Johnson (JNJ) and AbbottLaboratories (ABT), which are diversified well beyond prescriptiondrugs. On July 15, J&J beat earnings estimates, thanks in partto a 13% jump in sales of consumer products and over-the-counterdrugs. J&J's hit products include Listerine, Tylenol, and mostrecently, Zyrtec, an allergy drug the company converted fromprescription to over-the-counter. Stephen O'Neil, an analyst forHilliard Lyons, writes in a report that he expects J&J to tradeat a 15% premium to the S&P 500 "due to its diverse business,high returns, and strong financial condition." He adds that "no oneproduct or business is likely to dominate [the company's] results,"helping it to weather disappointments in its medical devices anddrug units. Johnson & Johnson's stock has returned 3% thisyear. The S&P 500, by contrast, has lost 16%, and the S&P500 Health Care Index is down 10%.
More merger-and-acquisition activity might fuel rallies in somecompanies' shares. Picking the right targets could be a challenge,though. Even though Roche had long owned a majority of Genentech'sshares, few expected the Swiss giant to swoop in and buy the rest,because European executives there swore they preferred to maintainan arms-length relationship with the South San Francisco [Calif.]biotech. Barr, on the other hand, was a more obvious takeovertarget; the generic drugmaker's shares had lost 23% of their valuein May amid fallout from a surprisingly bad earnings report.
Barr serves as yet another reminder of how one piece of bad newscan change virtually everything for a drugmaker in a flash. In astorm, the drug sector may be a beacon to risk-tolerant investors.But a safe haven it's not.