The drug industry is staring at a $30 billion hole. That's the
annual sales volume of major drugs that are set to lose patent
protection in the next 18 months.
Pfizer's (NYSE:
PFE
)
cholesterol reducer Lipitor,
Bristol-Myers Squibb's (NYSE:
BMY
)
blood-clot preventer Plavix,
Merck's (NYSE:
MRK
)
asthma medication Singulair, and
Abbott's (NYSE:
ABT
)
cholesterol reducer Tricor are all set to see a steep drop in sales
once that happens.
Ely Lilly (NYSE:
LLY
)
has the bad fortune of losing two major drugs -- Cymbalta and
Zyprexa (both used in the treatment of mental illnesses) -- and
it's unclear how these companies will make up for the loss.
The looming deadlines have been in focus for several years, and
these firms have been scrambling to either develop or acquire new
drugs to fill the hole. Trouble is, their research and development
machines are generating more failures than winners, and analysts
expect to see sales steadily decline for the next five years.
Even the firms that saw the patent nightmare looming and took
action still can't escape the tidal wave of generics. Bristol-Myers
Squibb appears to have a fairly impressive drug pipeline, but it
will be hard pressed to make up for the loss of four drugs by 2015
that account for 49% of current sales.
To combat those top-line pressures, most of these firms have
started to aggressively cut their workforces, which is temporarily
helping to boost thebottom line . Most drug companies plan
deeper cuts in 2011, though analysts seem to doubt there is any fat
left to cut and wonder if currentearnings forecasts for 2011 need
to be reduced.
With such a gloomy outlook, the entire sector has lost the respect
and attention of money managers. That's precisely why this is a
good time to pay attention, because the drug sector has real
pockets of strength, if you know where to look. Here's a short look
at a few firms that actually have real growth prospects in this
otherwise beleaguered industry.
Abbott Labs
Abbott's management saw this train wreck and started taking action
a few years ago. They realized the importance of keeping many irons
in the fire -- an approach that is now paying off. Whereas most
drug firms bet the ranch on internal drug development or risky
acquisitions, Abbott made sure that it also had exposure to
diagnostic equipment, nutritional products and cardiovascular
devices. That diversified approach has enabled Abbott to boost
sales a likely 14% in 2010. As a result, Abbott is in a position to
hike itsdividend for the 39th straight year in 2011.
But the real story here is pharmaceuticals. Abbott has been quietly
building up an impressive pipeline of drugs, many of which are
yielding very favorable results in clinical trials. These include
ABT-450/r (treatment of hepatitis C), bardoxolone (treatment of
chronic kidney disease), daclizumab (immunosuppressive),
briakinumab (treatment of plaque psoriasis) and elagolix (reduces
pain from endometriosis). The pipeline was bolstered by a 2010
acquisition of biotech firm Facet, which is pursuing a range of
therapies in immunology and oncology.
Outside of drugs, Abbott remains as a one of the leading players in
cardiac stents. A new stent being tested called ABSORB looks to
have blockbuster potential. "If Abbott succeeds in proving the
advantages of its dissolving stent over the existing stents, then
it could be a major breakthrough for the company," noted analysts
at First Global Securities in a recent report.
Shares of Abbott have drifted back toward the 52-week low in
recent months as the company had to initiate a costly recall of its
Similac baby formula from the market.The company more recently
conceded that a promising psoriasis drug would be de-emphasized in
the near-term.Shares now trade for about 10 times projected 2011
profits, a multiple that is in-line with its Big Pharma peers, but
below diversified health care stocks such as
Johnson & Johnson (NYSE:
JNJ
)
and
Baxter International (NYSE:
BAX
)
.
Venturing abroad
Some suggest that European drug stocks hold the greatest growth
prospects. Goldman Sachs, for example, recommends
Roche Holdings (RHHBY.PK )
and
Shire Pharma (Nasdaq:
SHPGY
)
, and eyes at least 30% upside in each name. Roche recently
acquired Genentech, immediately transforming it into a biotech
powerhouse with an impressive drug pipeline. Shire is growing at a
solid clip thanks to increasing worldwide demand for its drugs that
treat attentiondeficit hyperactivity disorder.
Eli Lilly
Perhaps no stock is more vulnerable than Eli Lilly, which stands to
lose all three of its top drugs (Zyprexa, Cymbalta and Alimta) in
the next 30 months. Were it not for a 2008 acquisition of oncology
firm Imclone Systems, Lilly would be poised for sharp annual
revenue drops. As it stands, sales are expected to drop 2% this
year, around 5% in 2012 and perhaps more than 15% in 2013.
To help thebottom line , management is already halfway through a
plan to shed 5,500 employees. Despite that, 2010 is increasingly
looking like the peak year ofearnings for the firm.Earnings per
share (
EPS
) are expected to fall by 7% in 2011 and perhaps at a double-digit
rate in subsequent years. Don't be tempted by that juicy
5.6%dividend yield . Analysts increasingly suspect that Lilly will
have to slash thedividend to preserve cash, a move that could
trigger an exodus of income-oriented investors from the stock.
Action to Take -->
Several years from now, Abbott Labs is bound to look far healthier
than Eli Lilly, even though both firms have somewhat
comparableearnings multiples. The firm should be a solid portfolio
candidate for investors. The contrasting situation with these firms
also sets up a nice potential pair trade for investors looking for
a name on both the long and short side.
-- David Sterman
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Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
