Pharmaceutical stocks are looking healthier

May 18, 1994|By Andrew Leckey | Andrew Leckey,Tribune Media Services

Pharmaceutical stocks, infected by a lingering health-care reform virus for the past year, have taken a sudden turn for the better.

They've recently managed to post a recovery of sorts, thanks to drug companies' aggressive attempts to reposition themselves for the managed-care environment of the future. These stocks are also now being considered by investors for their strong dividends rather than solely price appreciation.

Merck & Co.'s acquisition of mail-order firm Medco Containment last year was the first major move to adjust to changing trends. Now other competitors are catching up.

Roche Holding has agreed to buy troubled drugmaker Syntex for an amazing $5.3 billion, creating the world's fourth-largest pharmaceutical company. In addition, SmithKline Beecham agreed to buy Diversified Pharmaceutical Services, a discount-drug marketer; Pfizer Inc. and Value Health announced they'll create a managed-care unit; and Eastman Kodak intends to sell its Sterling Winthrop over-the-counter drug unit.

Speculation followed all this activity, talking up the takeover potential of companies such as Carter-Wallace, Eli Lilly, Ivax Corp., McKesson Corp., Schering-Plough, Upjohn Co. and Warner-Lambert. Yet there's quite a bit to recommend reasonably priced drug stocks apart from that potential.

"I'd be a bit cautious the next three to six months, for debate over health-care reform legislation will likely result in volatility," said Ronald Nordmann, analyst with PaineWebber Inc. "But I'm more optimistic looking out 12 to 18 months, and expect the 3 to 4 percent earnings growth of 1994 will increase to about 8 percent in each of the following five years."

Investors should own pharmaceutical stocks because drugs are effective in bringing down the overall cost of health care, he notes. For example, $25,000 surgery for ulcers and $11,000 surgery for congestive heart failure have been replaced by drug treatments that accomplish the same results.

"This isn't the industry of five years ago that had a 20 percent growth rate," warned Robert Hodgson, analyst with Cowen & Co., who doesn't expect a rush of acquisitions but does expect consolidations of equals and also numerous alliances. "On the positive side, prices are very cheap, average dividend yield is a ,, strong 4.5 percent, and earnings per share should grow at an 8 percent clip."

Biotechnology stocks also have had difficulties the last 12 months, although larger firms have lately seen their stock prices perk up.

"The Syntex acquisition, though an expected consolidation, was significant because the price paid was double most estimates," observed James McCamant, publisher of the respected Medical Technology Stock Letter, P.O. Box 40460, Berkeley, Calif. 94704 (annual subscription price $320 for 24 issues). "Don't overlook the fact large pharmaceutical firms have a lot of cash."

Bullish on biotech, McCamant nonetheless doesn't expect a large number of biotech acquisitions by large drug companies. Most deals haven't been successful in the past due to the dissimilar corporate cultures involved. On the other hand, he's pleased that it's looking like health-care legislation won't include a "breakthrough drug committee" that would get involved in prices of new drugs.

Don't chase down-and-out companies based strictly on takeover potential, say the analysts. Instead, pick quality companies likely to perform well in their own right. Buy gradually on down market days.

Pfizer, expected to have earnings growth of 16 percent over the next five years thanks to a strong product pipeline, is recommended by Nordmann and Hodgson. It's also benefiting from restructuring of its businesses. Bristol-Myers Squibb, categorized as down-and-out, is suggested by Nordmann because significant corporate downsizing could improve its bottom line.

Schering-Plough, blessed with innovative products and a strong consumer business, is a favorite of Hodgson and should have 13 percent earnings growth through 1997. Eli Lilly, another Hodgson selection, could have 10 percent to 12 percent annual earnings growth if it spins off or sells its medical devices business as it plans to do.

In mid-capitalization stocks, Forest Labs is a Hodgson pick because it should have 25 percent growth through 1997 and has four new drug applications in the next two years. Two stock choices in drug delivery are Alza Corp. and Elan Corp. Hodgson's small-capitalization stock selections include Mylan Labs and Alliance Pharmaceutical.

Chiron Corp., the best-managed biotech firm and priced well below its high, is a McCamant favorite. Other picks are ProCyte Corp., in Phase II (of III) trials of its wound-healing drug; ImmunoGen Inc., in Phase III trials of a treatment for B-cell lymphoma; and Celtrix Pharmaceuticals, in Phase III tests of a treatment for blindness-causing macular holes in the human eye.

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