Another Year Of Magic For Pills And Potions

If you were looking for action in 1995, pharmaceutical stocks were just what the doctor ordered. U.S. health-care reform died, and with it fears that drugmakers would see their sales sharply limited. Widespread cost-cutting in the industry helped turn profits around after a slump in 1994. The sector also saw a wave of megamergers, starting with the $14 billion combination of Britain's Glaxo PLC and Wellcome PLC in January and winding up with the widely praised marriage between Sweden's Pharmacia and Upjohn Co. of the U.S. All that news pushed global pharmaceutical stocks through the roof: In the U.S., the group outperformed the Standard & Poor's 500-stock index by 18%, and in Britain the pharmaceutical sector returned 29% more than the benchmark Financial Times-Stock Exchange 100 index.

It's a tough act to follow, but some experts think more gains could lie ahead. The difference this year, says Richard Vietor, first vice-president at Merrill Lynch & Co. in New York, is that "earnings growth will shift from cost-cutting to fundamentals." That means investors may want to focus on companies with significant new products in the pipeline. In the U.S., for example, Pfizer Inc. is expected to launch four drugs from 1996 to 1998, including a nonsedating antihistamine and a novel antiarthritic. And Merck & Co.'s new Fosamax, an osteoporosis treatment, is getting positive early reports. Such innovations are expected to push their creators' earnings growth rates above the average 7%-to-10% forecast for the industry in 1996.

In addition, while the pace of consolidation among drug companies is bound to slow--if only because fewer merger candidates remain unattached--the trend isn't over. Glaxo-Wellcome, the world's biggest drugmaker, still has only 6% of the global market. So, many industry watchers expect companies to continue combining until only 10 or 15 giants are left. In Britain, rumors of a bid for Zeneca Group PLC pushed its stock price up 51% during 1995--and the whispers continue.

Takeover plays aside, analysts believe that there are enough stocks with upside potential left to build a healthy portfolio (table). Switzerland's Sandoz is widely recommended as it continues to divest noncore assets--"changing its spots and focusing on what it does best," says Salomon Brothers analyst Peter Laing. Also, Sandoz's pipeline includes the Alzheimer's drug Exelon, for which the company is expected to seek Food & Drug Administration approval by the end of 1996.

REAL SLEEPERS. Sweden's Astra also gets high marks, in part because its stock is relatively inexpensive. "Astra looks like one of the most undervalued [drug] companies in Europe," says Kevin Scotcher, who follows the industry for Kleinwort Benson Ltd. in London. Its projected price-earnings ratio of 17.6 compares with a starry 37.5 for industry highflier Roche. Another plus: The patent for Losec, Astra's ulcer medication, doesn't expire until 2004--six years after the first patent on Glaxo-Wellcome's competing drug, Zantac, runs out.

Although most investors have chased the hot transatlantic drug-industry action, some savvy stock-pickers think the real sleepers are in Japan. Samuel D. Isaly, manager of the Capstone Medical Research Fund and a partner with industry analysts Mehta & Isaly, believes that "Japanese pharmaceuticals are very attractively valued and will lead performance of the sector in 1996." His picks include Sankyo Co., whose cholesterol-busting Pravachol reduces mortality and already has worldwide annual sales of $1.1 billion. Isaly also likes Taisho Pharmaceutical Co., a leader in Japanese over-the-counter medications and developer of the powerful prescription antibiotic Biaxin. Price-earnings ratios for these stocks are no higher than those of Western competitors--and much lower than Japan's average 50.

As drug-stock fever spreads around the world, investors will have every reason to view the industry's lofty prices with caution. But if the pundits prove right, the flow of megamergers and exciting new products should continue to keep pharmaceuticals sizzling for some time.

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