A Bitter Pill for Generic Drugmakers?

While the industry should get a boost from patent expirations, it faces fierce competition from branded drug firms

By Herman Saftlas

Generic drug sales are expected to rise sharply over the coming years, boosted by a record $35 billion in sales of branded drugs going off patent over the next five years. The ongoing growth in managed care organizations, which typically are heavy buyers of generic drugs, is another positive trend. Generics' share of all U.S. prescriptions written was estimated at over 50% last year, up from 35% in 1992.

However, fierce competition and the inability to stabilize pricing often make generic drug stocks boom-or-bust investments. In recent years, generic firms have had to contend with new strategies employed by leading branded drugmakers to fight off generic competition. These include attempts to win consumer loyalty through heavy consumer advertising, petitioning Congress to grant patent extensions and developing newer versions of older, patent-expired products.

Drug delivery stocks have been volatile in recent months, reflecting heightened competition in many segments of the market and a general contraction in price-to-earning multiples in this group. Selected companies able to capitalize on enhanced drug delivery technologies should be the better performers of this sector.

Standard & Poor's index of generic drug producers and drug delivery companies fell 14.6% through May 11, compared with a 5.2% decline in the S&P Super 1500 index. The pullback reflects investors' rotation out of health care issues and into industries more likely to benefit from a lower interest-rate environment, increased competitive pressures and recent delays in the launch of several drugs.

Longer-range prospects for the generic industry are favored by a larger number of major branded drugs losing patent protection over the next few years and greater use of generics under President Bush's planned Medicare drug program. Demand for new drug delivery systems should also increase, as drugmakers employ them to improve their products.

S&P's outlook for the generic drug manufacturers is neutral. Due to strong competition and lofty valuations, S&P expects most leading generic drug and drug delivery stocks to perform in line with market indices in 2001.

S&P has a 5 STARS (buy) recommendation on Andrx Corp. (ADRX ).

S&P has 4 STARS recommendations (accumulate) for ALZA (AZA ), Biovail (BVF ), King Pharmaceuticals (KG ), and Teva Pharmaceutical (TEVA ).

Herman Saftlas is Standard & Poor's pharmaceutical analyst

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