Until a few weeks ago, drug analyst Joyce M. Albers at First Boston Corp. had been praising Bristol-Myers Squibb Co., urging clients to buy. The reasoning was simple. New products drive the drug business, and over the last several months, the world's second-largest pharmaceutical company introduced five of them, including a cholesterol fighter and a promising AIDS treatment. Given the impressive lineup, she says, "this should have been a very respectable year for the company."
It's not turning out that way. First-quarter earnings fell shy of expectations, but company officials assured Wall Street they would make it up in the second. Then, in early June, the bombshell hit. The company said second-quarter sales were weak, too, suggesting earnings may this time fall more than a little short. Bristol shares plunged nearly 7 points, and Albers and other analysts yanked their recommendations. Before the massacre stopped, the stock had dropped almost 15%, and many other drug stocks were also dumped.
`MUDDY BOTTOM.' Now, investors are often reminded that drug stocks can get sick, too. On June 17, Upjohn Co. said its second-quarter profits would show no gain over 1991--and the stock dropped 5.2%. "For the first time in 10 years, drug companies are suffering from fundamental earnings disappointments," says Michael K. Arends, who co-manages two growth mutual funds for Kemper Financial Services Inc. There's also other bad news casting a pall over the stocks. Days after Bristol's stunner, Abbott Laboratories withdrew Omniflox, a new antibiotic, from the market after it was linked to three deaths.
Investors didn't get too upset when drug stocks started to decline in early 1992 (table). But until a few weeks ago, most analysts took the drug slump to be temporary. Now, few expect a quick rebound. "It's hard to see how they're going to beat the S&P 500 this year," says Neil B. Sweig of Capital Institutional Services Inc. "They'll creep along the market's muddy bottom."
Investors have been unnerved by the drug stocks because the companies have for so long delivered steady double-digit earnings gains. That made the stocks golden. From 1989 through 1991, the drug stocks in the Standard & Poor's 500-stock index soared 162%, vs. 50% for the broad index. Big companies such as Merck and Bristol-Myers Squibb doubled, and Pfizer even tripled in price.
Now, however, the drugs are so beaten down that even those who buy stocks for yield are sniffing around. Take Roger Newell, who runs the Vanguard Equity-Income Fund. Newell says that based on their yields relative to other stocks, Bristol-Myers, with a yield of 4.3%, and Upjohn, at 4.2%, are about as cheap as they've ever been, and, like nearly all big drug stocks, they are high on cash and low on debt. But he's still buying cautiously. James H. Gipson of Pacific Financial Research Inc., is also taking soundings but is not ready to buy. "They look awfully cheap by their past growth rates," says Gipson. "But the industry fundamentals are changing."
The principal engine for drug company growth is still new products. But the big earnings gains of recent years didn't come from innovation alone. A good chunk came from price hikes that ran as high as three times the rate of inflation.
But the days of soaring drug prices may be over. Government and private industry, trying to rein in health care costs, are pressuring the drug companies as well as doctors and hospitals to keep prices in check. In fact, industry leader Merck & Co. has promised to keep increases in line with the consumer price index. Analyst Marc O. Mayer of Sanford C. Bernstein & Co. says the industry's earnings growth rate could improve in 1993, but it may never again equal last year's 18%.
FEW GAINS. The only way to win the drug-stock game is find those with the best "product pipelines." On that count, Merck and Pfizer Inc. are considered tops. Merck's prize new drug, Proscar, which treats benign enlargement of the prostate, is expected to get FDA approval later this year. Pfizer has new antidepressant and cardiovascular drugs in the works. Their stocks show it. They have declined the least, and their price-earnings ratios are still the highest and yields the lowest in their industry.
Even the Mercks and Pfizers may have trouble making gains. Institutions are neck-deep in drugs--not one company is less than 50% owned by pros--and they'll be looking to sell, especially by the end of the second quarter but perhaps all year. "No doubt drug stocks will be great opportunities," says Mayer. "But we're not there yet."