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Friday, July 16, 1999

FOOL ON THE HILL
An Investment Opinion
by Warren Gump

Learning About Warner-Lambert

Those of you have followed my writings probably know that I am quite fond of the biotechnology industry. With the innovations likely to emerge from this industry as genome research expands exponentially, I find few areas more attractive for long-term shareholders willing to endure stock price volatility inherent with companies working on revolutionary discoveries. Up to this point, most of my writing has been on pure-play biotech companies like Amgen (Nasdaq: AMGN), Biogen (Nasdaq: BGEN), and Immunex (Nasdaq: IMNX). But these firms aren't the only way to gain exposure to the industry. Traditional pharmaceutical companies are also quite involved in the sector.

What's the advantage of investing in one of the old-line drug companies over a full-fledged biotech operation? Primarily the fact that these companies have a broad base of existing products that generate growth and help finance R&D efforts. The major biotech companies only have one or two major products currently on the market, whereas most of the big pharmaceutical companies are selling many drugs. Given their sheer size, the traditional drug companies also have more money to invest in R&D. Pfizer (NYSE: PFE) and Merck (NYSE: MRK) each will spend well over $2 billion on R&D this year, whereas Amgen, the biggest biotech company, will invest $850 million. On the other hand, those dollars are invested over a wider array of efforts and any individual new product must be bigger to have a material impact on the larger pharmaceutical firms.

I find many of the big drug companies interesting. One that really catches my eye, though, is Warner-Lambert (NYSE: WLA). Right now the company is achieving tremendous results with its Lipitor cholesterol drug and its aggressive move to expand its presence in the biotech arena. Earlier this year, the company issued stock worth $2.1 billion to acquire Agouron Pharmaceuticals, which uses genetic engineering extensively in its drug development process. Beyond its currently marketed Viracept protease inhibitor, Agouron has several drugs in its pipeline to help treat cancer and HIV/AIDS.

Before talking about the pharmaceutical side of Warner-Lambert, it is important to realize that the company has two other divisions. The consumer health care group sells products like Rolaids, Sudafed, Lubriderm, Benadryl, Listerine, and Schick shaving supplies. Last year, it achieved sales of $2.7 billion (27% of the company's total) and $510 million in income before taxes (24%). The confectionary business, marketers of items such as Chiclets, Dentyne, Certs, and Halls cough tablets sold $1.9 billion of products (18%) and earned $159 million before taxes (7%). These divisions have seen sales and earnings declines over the past two years, but they generate cash flow that helps fund the company's other operations.

Pharmaceuticals account for the majority of Warner-Lambert's business. Last year, this division had sales of $5.6 billion (55%) and income before taxes of $1.5 billion (69%). The phenomenal success of Lipitor and Rezulin, a diabetes drug that has likely seen revenue peak, have fueled a doubling of sales and a tripling of profits in the pharmaceutical segment.

Rezulin had been a hot shot, with sales moving up 78% to $748 million from $420 million in 1997. With the recent introduction of an effective competitive product, however, Rezulin has been made a second-line defense. In isolated instances, Warner-Lambert's drug has been associated with severe liver problems (including deaths). Although that drug now faces declining sales, soaring sales of Lipitor, which is co-promoted with Pfizer, should more than offset that downturn. After doubling last year to $2.2 billion, the company expects Lipitor's sales to reach $3.3 billion this year and $4 billion in 2000.

The company has additional drugs experiencing substantial sales growth. Revenue from anticonvulsant Neurontin shot up 76% to $514 million, while antihypertensive Accupril enjoyed 20% sales growth to $454 million. Viracept, the protease inhibitor picked up in the Agouron acquisition, should also boost sales. Over the past 12 months, the drug had $500 million in revenue -- with the latest quarter's sales still growing 30% over the prior year.

Sustaining the company's growth is highly dependent on finding new therapies. If recent history is any indication, things are looking good. In the past year, Warner-Lambert began co-promoting Celexa, a depression treatment, with Forest Laboratories (AMEX: FRX). Estimated sales for the year will be $300 million. The company also introduced a new antibiotic, Omnicef, which has been well received. To help ensure a healthy flow of new products, the Warner-Lambert is dramatically pumping up R&D spending. Current year expenditures for this line item are projected to rise 33% to $1.2 billion.

With pharmaceuticals comprising a major portion of the company's overall operations, Warner-Lambert's margins are quite impressive -- although not as high as other pure pharmaceutical firms due to the consumer health and confectionary operations. Gross margins were 74%, up from 68% two years ago as the positive impact of Lipitor and other drugs took effect. For the same reason, the company's operating margin increased from 16% to 17%. With strong cash flow, the company's balance sheet is pretty clean. Although $1.5 billion in debt sits on the balance sheet, this is mostly offset by $1.2 billion in cash.

With such a powerful lineup under its belt, Warner-Lambert might be worth investigating to gain exposure to the drug/biotech sector. If you are interested in learning about the company, you might want to check out its website. (They don't yet have an obvious link to the Agouron site, which gives you information on their novel drug discovery process.)

One nice aspect of Warner-Lambert is its investor-friendly dividend reinvestment program. In addition to allowing optional cash payments, you can avoid a broker altogether and purchase your first shares directly from the company for a $15 fee (the minimum initial investment is $250).

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