The Best in Drugs and Biotech

S&P's Herman Saftlas and Frank DiLorenzo share some favorites in these resurgent sectors, including Barr Pharmaceuticals and MedImmune

There's a prescription for promising investments in both the pharmaceutical and biotechnology sectors. So say Standard & Poor's analysts Herman Saftlas, speaking for the pharmas, and Frank DiLorenzo on biotech. DiLorenzo reports that biotechs have been outperforming the S&P 500 index, and Saftlas adds that pharma stocks are back with the market uptrend, having sagged in the second quarter. S&P has several strong buys, DiLorenzo says, including Amgen (AMGN ), Celgene (CELG ), Genzyme (GENZ ), Martek Biosciences (MATK ), MedImmune (MEDI ), and Millennium Pharmaceuticals (MLMN ).

None of the large pharmaceutical companies rates a buy from S&P, according to Saftlas, but he does have that top rating on Barr Pharmaceuticals (BRL ) and Mylan Labs (MYL ). And on the next rank down (accumulate) he cites Wyeth (WYE ), Pfizer (PFE ), and Eli Lilly (LLY ).

These were some of the points Saftlas and DiLorenzo made in an investing chat presented Sept. 16 on America Online by BusinessWeek Online and Standard & Poor's, in replying to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts follow. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Note: Herman Saftlas and Frank DiLorenzo are analysts with Standard & Poor's Investment Advisory Services. They have no affiliation with or ownership interest in any companies under discussion. Other S&P affiliates may provide services to the companies under discussion.

Q: How have the pharma and biotech sectors been doing relative to the S&P 500's performance?

DiLorenzo:

Biotech has outperformed significantly this year.

Saftlas: On the pharma side, earlier in the year they were going in tandem with the market, then slipped in the second quarter. More recently they have joined in the uptrend.

Q: What are your 5-STAR [strong buy] picks in the pharma and biotech space?

Saftlas:

In the large pharma area, I don't have any 5-STARS. And I have two 5-STARS in the generic space. They are Barr Pharmaceuticals (BRL ) and Mylan Labs (MYL ).

DiLorenzo: On the biotech side, our 5-STAR stocks include Amgen (AMGN ), Celgene (CELG ), Genzyme (GENZ ), Martek Biosciences (MATK ), MedImmune (MEDI ), and Millennium Pharmaceuticals (MLMN ).

Q: Also, can you list the 1-STARs [sell] as well? Are there any, or any 2-STARs (avoids)?

DiLorenzo:

On the biotech side, we don't have any sells or avoids only because the market has been extremely strong, and it's difficult to go against the positive uptrend in biotech right now.

Saftlas: I also don't have any sells or avoids at the present time for the same reasons -- positive outlook.

Q: What about valuations in your areas? Are they a problem for some stocks?

Saftlas:

In the pharma area, the current p-e valuations are very comparable to the market. Many actually trade below the market -- the average is close to the market. In the specialty generic area, many sell above the market.... That reflects the stronger growth prospects in that segment.

DiLorenzo: Overall, considering the strong growth rates we expect for biotech, we think the multiples are reasonable. The one stock that has a higher relative valuation in comparison to other biotechs would be Genentech (DNA ).

Q: What do you see in Pfizer's (PFE ) future?

Saftlas:

I still expect PFE to post strong mid-teens or better EPS [earnings per share] growth over the next few years. That reflects significant cost savings from the recent merger with Pharmacia. And they have a pretty strong pipeline of new drugs that should power top- and bottom-line growth.

Q: Any opinion on Ivax (IVX ) or Elan (ELN )?

Saftlas:

I cover Ivax, I don't cover Elan. I have a hold rating on Ivax. Ivax is a very strong company with 39 generic submissions before the FDA, and they just today announced plans for a generic tablet form of Pfizer's Neurontin drug. They also have some new products in the respiratory area.

The only concern is that they have a very large capital base -- something like 195 million shares -- and earnings per share this year of only about $0.70 (that's what we're projecting). Therefore, the p-e is...relatively higher than average.

Q: Where do you see Eli Lilly (LLY ) in a year or two from now?

Saftlas:

We have a hold ranking on Eli Lilly, but we do see the company resolving its manufacturing problems. And we do see new products eventually getting approved. That should support 12 months from now a price target of $68.

Q: How about Abbott Laboratories (ABT )?

DiLorenzo:

We're positive on the stock overall. Our current rating is an accumulate. The main catalyst we see for adding value includes strong growth in sales of Abbott's pharmaceutical products, led by Humira. The drug is also being testing in a number of other inflammatory conditions (it's currently used for rheumatoid arthritis).

We expect a rebound in 2004 in Abbott's nutritional products. We also expect a rebound in sales of U.S. diagnostic products, assuming Abbott can resolve compliance issues with the FDA by the end of this year. I would also note that in our opinion we view the planned hospital-products spinoff positively, since we believe it will allow Abbott to focus on higher-growth areas on a long-term basis.

Q: Amgen -- is it too high to buy at this time?

DiLorenzo:

We actually have a buy on Amgen -- and still think it's a good value if you're looking at things from the long-term perspective. We expect sales of Aranesp, Neulasta, and Enbrel to grow very solidly over the next three years. We also believe that a recent deal with Biovitrum for its investigational diabetes medication could provide a good product candidate in the second half of the decade, although it's still too early to draw any conclusions, since the drug is still in earlier-stage trials.

In 2004, we expect approval of Enbrel for the treatment of psoriasis and Cinacalcet to treat secondary hyper-thyroidism. Considering the company's growth prospects and overall product outlook, we think it's attractively priced.

Q: What therapeutic areas hold the best opportunity for blockbuster drugs?

Saftlas:

There can be blockbusters in almost any area. Generally, the pharma companies try to target therapeutic areas that have large patient populations. That includes cancer or heart disease, diabetes, depression -- things of this nature.

DiLorenzo: On the biotech side, the areas where you have the greatest areas for upside would include cancer, autoimmune disorders, and neurological conditions. Those three areas probably offer some of the greatest potential.

Q: Which generic drug companies do you like for the next few years?

Saftlas:

Barr Laboratories and Mylan Laboratories. We also like Teva (TEVA ). On a more speculative note, we like Andrx (ADRX ) and Biovail (BVF ).

Q: Frank, could we tell us your criteria at S&P for deciding whether to cover a biotech company? I know there are many, many small ones.

DiLorenzo:

We try to look at companies that at the very least have a promising clinical candidate in late-stage development, preferably Phase 3, as well as a strong cash position that could carry a company's operations over at least a three-year period so that it can at least be profitable.

Q: Will Gilead Sciences (GILD ) continue to grow?

DiLorenzo:

If the company's revenues continue to grow, they should grow strongly into the 2005 time frame. We think the stock can continue to move up -- just not at the rapid pace it has over the past 12 to 15 months. We do expect the company to increase in size. We have a positive outlook on it on a long-term basis, primarily due to our expectations for Viread and Emtriva for the treatment of HIV.

Q: Since Fred Hassan was able to turn around Pharmacia, what do you foresee for the prospects of Schering-Plough (SGP )?

Saftlas:

We recently raised our opinion on SGP from sell to hold. To some extent, that does reflect our confidence in Hassan's ability to achieve a turnaround at SGP, as he has overseen such turnarounds at Pharmacia and other companies in the past. However, the task is much more formidable at Schering because the key drugs there are facing intense generic and other competition. The new-drug pipeline has to be revitalized, and significant cost-cutting has to be done. Once those objectives are achieved, I believe that would be a platform for the stock going higher.

Q: What's the best way to invest in this sector?

Saftlas:

In looking for investments in the pharma sector, you look for companies with strong drug portfolios that are protected from patent expiration over the foreseeable future. No. 1, you look for strong management with a proven track record. And you study each pipeline, looking for those with promising drugs in the late-stage pipeline.

Q: Do you agree, for biotech, Frank?

DiLorenzo:

I generally agree with that. For biotech, I would recommend concentrating a large portion in profitable companies with EPS growth prospects of 20% or more and reasonable multiples.

Q: Especially for the later arrivals, how about giving us a refresher on the pharma and biotech stocks you like best now?

Saftlas:

The 5-STARS I have are Barr Labs and Mylan Labs. And I do have in the big pharma sector 4-STAR accumulates on Wyeth (WYE ), Pfizer, and Eli Lilly.

DiLorenzo: The 5-STARS I have are Amgen, Celgene, Genzyme, Martek, MedImmune, and Millennium.

Edited by Jack Dierdorff

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