Winners and Losers in Big Pharma

Pharmaceuticals are historically a defensive place to park one's money when the market tanks. So with housing, retail, financial, and manufacturing stocks now struggling left and right, can investors still count on the drug companies to boost their portfolios?

In some cases, yes, but not across the board. Big pharma has its hands full with patent expirations on blockbuster drugs, failures on other drug studies, and an increasingly difficult regulatory environment. Just consider what GlaxoSmithKline (NYSE: GSK  ) CEO Jean-Pierre Garnier had to say during the company's recent earnings conference call: "There is a bit of a slowdown at the FDA. I was looking at stats on the NDAs going through the FDA; I think four out of five get an approvable letter now."

That's a shocking statistic. What it means is that four out of five drugs submitted to the FDA with a New Drug Application, or NDA, are not getting approved on their first submissions. That's really bad news for developers, because getting an approvable letter usually means a delay of at least a year in getting a drug on the market, and it often entails extra research and development costs to generate new data that will satisfy the FDA's requests.

The FDA will continue approving drugs, though, and drug companies will just have to adjust to give the agency what it wants. With most pharmas having already reported their third-quarter results, it's a good time to take a look across the industry. What we'll see is that the news isn't bad everywhere.

Company

Market Cap (Billions)

Revenue (Billions)*

Revenue Growth*

Dividend Yield

Eli Lilly (NYSE:LLY)

$60

$17.7

15.4%

3.2%

GlaxoSmithKline

$142

$46.8

(2%)

3.9%

Merck (NYSE:MRK)

$125

$24.0

7.3%

2.6%

Novartis (NYSE:NVS)

$120

$40.1

21.4%

1.8%

Pfizer (NYSE:PFE)

$170

$48.2

(0.3%)

4.8%

Wyeth (NYSE:WYE)

$66

$21.9

10%

2.3%

*Revenue and growth are on a trailing-12-month basis.
Source: Capital IQ, a division of Standard & Poor's.

Now, let's work on separating the superstars from the mediocre performers.

Benchwarmers
GlaxoSmithKline is in the midst of a rough patch; Avandia and its Coreg franchise are wavering. And you know things are tough when job cuts are a way to trim expenses. For the long term, I do like Glaxo, in part because of the inroads it's making in oncology, and also because of the blockbuster potential of Cervarix. The human papillomavirus (HPV) vaccine candidate comes up for approval in January. Right now though, Glaxo is just not keeping up with the pace that some of its peers are setting, but the generous 3.9% dividend yield could keep patient investors happy until the pipeline pays off.

Pfizer, meanwhile, is a cash cow. It's generating obscene amounts of free cash flow and offering a generous 4.8% dividend yield. And on top of all that, it will buy back $10 billion of its shares this year. On the downside, the company will lose too much revenue to patent expirations in the next few years to give it the nod over better-positioned competitors. Along with flagship product Lipitor, Pfizer is losing Camptosar, Xalatan, and Aricept. New drugs, including Sutent and Chantix, have to be successful just to keep Pfizer running in place -- which is exactly what its top line has done for four years in a row.

Wyeth is also dealing with patent difficulties. Its top seller, Effexor XR, will face generic competition in 2010 -- and possibly earlier, with some generic challenges still under way. Whenever the generics emerge, they will be a big blow to Wyeth, since Effexor generated 17% of the company's revenue in the most recent quarter. Fortunately, Wyeth has some strong performance to lean on from other products, as well as some attractive R&D -- especially in its Alzheimer's program in collaboration with Elan (NYSE: ELN  ) .

All-Stars
Count me as a fan of Eli Lilly. It just turned in a very solid quarter; it pays a great dividend; and unlike many of its brethren, it's not facing major patent losses until next decade. Management just raised 2007 earnings guidance, and the stock is trading at an attractive 19 times earnings. Lilly's a great drug stock for the long haul.

Over in Switzerland, Novartis has made sound strategic moves into the generic-drug business to support its strong portfolio of branded drugs. I'm also very bullish on Novartis for its early move into follow-on biologics. In the next decade and beyond, a lot of money will be made in that area, and Novartis' push today will reap rewards for investors for years to come.

MVP
Our biggest star here, Merck, has been on fire. While other stocks are crashing, this one is setting new 52-week highs. Top drugs Singulair, Januvia, Gardasil, and the Zetia/Vytorin combo are driving double-digit revenue growth. With a number of new drugs on the way, the Vioxx debacle under control, and less patent exposure than some of its peers, Merck once again has to be considered one of the top dogs of the drug industry.

The prescription
Although some companies are stumbling in the pharma sector, others are turning in a very strong performance and could serve as the cornerstones of any portfolio, even as other sectors of the economy struggle. Choose carefully, but don't ignore the sector altogether.


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