Taking the Drug Industry's Temperature

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Investors trying to predict the health of the pharmaceutical business should pay attention to research & development, rather than mergers and acquisitions.

Sure, the big M&A deals -- Pfizer (NYSE: PFE) and Wyeth, or Merck (NYSE: MRK) and Schering-Plough (NYSE: SGP) -- capture the headlines. But the true lifeblood of the industry, research and development, can bese be measured by the health of companies such as Covance (NYSE: CVD) and Icon (Nasdaq: ICLR).

These contract research organizations, or CROs, conduct anything from pre-clinical tests to late-stage clinical trials for big drugmakers that want to reduce costs, and for small companies that can't afford expensive late-stage tests.

Judging from recent results for Covance and Icon, the R&D outsourcing business looks like a flu patient whose fever may have broken, but who hasn't completely shaken a nagging cough.

Prognosis for recovery
For the third quarter, Covance matched Wall Street's expectations with earnings per share, excluding special items, of $0.67. It edged past the consensus net revenue estimate of $468.8 million with $475.3 million. Revenue rose 8% compared to the year-ago period.

As for Covance's nagging cough, the company predicted fourth-quarter earnings would be in a range of $0.64 to $0.67, below the Wall Street forecast of $0.72.

Despite that, investors liked Covance's results, bidding shares up by more than 4% yesterday.

A healthier outlook
Icon looked healthier, even though third-quarter revenue of $220.3 million fell 2.3% year over year. Icon's $0.40 in earnings per share, excluding one-time events, beat the Wall Street consensus by $0.06 per share, and the year-ago quarter by $0.05.

But Icon's still plagued by "higher than normal [contract] cancellations," a significant risk factor. The company's managed to rally enough to raise its full-year EPS forecast, excluding one-time items, to a range of $1.48 to $1.52. The previous prediction was $1.38 to $1.44.

Upping guidance is always happy news for the market; shares have risen more than 10% as a result.

CRO investors know that although the industry has a common goal, companies employ different strategies. Keep an eye out during the next two weeks, when Pharmaceutical Product Development (Nasdaq: PPDI), Parexel International, and Charles River Laboratories (NYSE: CRL) offer their financial prognoses.

When earnings season coincides with the flu season, investors must guard against a relapse.

Using CROs is one way pharmaceutical companies can reduce costs. If health-care reform makes it past Congress, how likely do you think that companies like Icon and Covance will benefit? Click over to CAPS and share your thoughts by rating them outperform or underperform.