Pharmaceuticals favored despite lawsuits

Strong balance sheets, earnings potential win support from analysts

Your Money

June 26, 2005|By Andrew Leckey

File two lawsuits and call me in the morning.

That has been the prescription for dealing with drug side effects lately. As a result, the pharmaceutical industry is in a fever over class action lawsuits, large settlements and Food and Drug Administration actions.

But, experts said, that doesn't necessarily make them bad investments.

Eli Lilly & Co. recently established a $690 million fund for plaintiffs who agree to settle claims that they developed diabetes-related conditions from its antipsychotic drug Zyprexa. It has settled dozens of lawsuits involving the antidepressant Prozac.

The stock of Lilly barely moved on news of its Zyprexa settlement. In fact, Albert Rauch, pharmaceutical analyst for A.G. Edwards & Sons Inc., is recommending it.

"Investors aren't so worried about one-time events because these companies have strong balance sheets, and their cash flow is of more concern," said Rauch, noting the companies also have insurance covering such events. "Once payment is made, it is history, and investors look at the future earnings stream to value the stock."

More than 2,000 cases have been filed against Merck & Co. over the withdrawn pain reliever Vioxx, and some experts estimate potential liability could reach $18 billion. A study has indicated long-term use of Vioxx increased a patient's risk of heart attack and stroke.

Amid the tumult, Bristol-Myers Squibb Co. pledged not to promote any new medicines directly to consumers for at least a year. It instead will market new products to doctors and develop consumer advertisements about the conditions the medicines treat.

All this could leave some investors in drug stocks with a queasy feeling in their stomachs.

"Medicine and science are targeting serious diseases with new products, and a lot is going through the FDA pipeline," said Dana Taschner, a Los Angeles attorney specializing in product and drugmaker liability cases who is representing Vioxx plaintiffs. "The nature of reporting about global products is that there may already be 100 adverse reports by the time the FDA is even cognizant of it."

Legal activity is accelerating because lawyers are aggressively pursuing these types of cases.

One reason Rauch likes Lilly's stock is a federal court's dismissal in April of legal challenges from three generic manufacturers to Lilly's Zyprexa patent, which delays generic competition. In addition, he said, the company's pipeline of new products looks impressive.

It's not alone.

"I believe some people have overestimated the Vioxx liability of Merck, which has obscured some of the new drugs that it has," said Michael Krensavage, New York-based pharmaceutical analyst for Raymond James Financial Inc., who recommends Merck. "I tend to prefer drug companies that seem down and out, such as Merck, because their stocks trade at a discount to their peers."

An attractive stock and an attractive company are not necessarily the same thing, Krensavage warned. Once a downtrodden company cures its problems, you will be rewarded. There's greater risk in getting caught up in hype surrounding the prospects of a brand-new drug that might not meet expectations.

"Many drug companies made the mistake in the late 1990s of being more focused on marketing than research," said Le Anne Zhao, pharmaceutical analyst for Caris & Co. in New York, who said she believes more initial emphasis was placed on spending to advertise Pfizer Inc.'s erectile dysfunction drug Viagra than in discovering possible side effects that since have surfaced.

"You're seeing a drought in research and development productivity, patent expirations and political pressures all coming together at once."

Advertising hype can have a negative impact, she said. Physicians are far more aware of diseases and potential consequences of certain patients using pharmaceutical products than are consumers who simply see products on television and ask their doctor for them.

Most recommended drug stocks have something to prove.

Schering-Plough Corp., known for the allergy drug Claritin, anti-infectives, cancer drugs and co-promotion with GlaxoSmithKline of erectile dysfunction drug Levitra, is a turnaround candidate recommended by Krensavage and Rauch. Its new management team's launch of the cholesterol drug Vytorin was particularly successful.

Pfizer, which is acquiring the bacterial and fungal-infection drug company Vicuron Pharmaceuticals Inc. for $1.9 billion in cash, is a Krensavage pick despite several FDA-related issues. The FDA had Pfizer withdraw arthritis drug Bextra from the market because of potential health risks and ordered new warning labels for the arthritis medication Celebrex. The FDA is studying Viagra to determine whether it can cause blindness.

Andrew Leckey is a Tribune Media Services columnist.

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