Drugs and Biotech: Just Say "Maybe"

Analysts Herman Saftlas and Frank DiLorenzo see a spotty recovery -- but a few stocks, including Pfizer and Amgen, may be worth considering

The market rally has been healthy for stocks of drug and biotech companies, although progress in the latter arena has been spotty. That's the view of Herman Saftlas, Standard & Poor's senior investment officer covering pharmaceutical stocks, and S&P's Frank DiLorenzo, who tracks biotech.

Currently, Standard & Poor's has no pharma stocks ranked buy, Saftlas says, but it does list several accumulates: Pfizer, Wyeth, Aventis, and Johnson & Johnson. In biotech, DiLorenzo mentions as buys Cephalon and Gilead Sciences, with Amgen as a stock to accumulate. He cautions that stocks of some of the emerging biotech companies are risky. Patent expirations also are a problem for some of the big pharmaceutical companies, but Saftlas sees new drugs fueling that sector's recovery.

These were some of the points Saftlas and DiLorenzo made in an investing chat presented Oct. 29 by BusinessWeek Online and S&P on America Online in response to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts from this chat follow. A full transcript is available on AOL at keyword: BW Talk.

Q: How does the market look to S&P? Does this rally have legs?


S&P's position on this is that the recovery has further to go -- we're moderately positive and cautiously optimistic at this point.

Q: Have the pharmas and biotechs participated in the rally?


Yes, the pharmas have participated partially in the rally, with a lot of the depressed stocks showing bounce with the market rally.

DiLorenzo: As far as biotech, it's been selective. Better-known, profitable names have done well, but other, less-known companies have continued to have problems.

Q: Frank, what can you tell us about the biggest of the biotechs, Amgen (AMGN )? Is this a good pick in this market?


I have an accumulate on Amgen. My view is that it's modestly undervalued. I expect two of its drugs, Aranesp and Neulasta, to continue to do well. However, I feel Enbrel will have difficulties due to competition. On balance, I like the portfolio and pipeline and think it's a good stock to have on a long-term basis.

Q: Herman, what about Bristol-Myers Squibb (BMY )? This is a company that has fallen into much trouble lately.


Bristol-Myers Squibb has had a very difficult year this year -- they've had problems with generic erosion in a number of major products, such as Glucophage, Buspar, Taxol. They've suffered from major inventory issues -- high wholesaler inventories caused by last year's channel stuffing. They've also had a write-off on ImClone stock (IMCL ). They've had negative FDA response to their experimental drugs. It's been a tough year. On the other hand, they are attempting to regroup and reconsolidate. They do have a good anti-psychotic drug called Abilify. And they are restating their earnings and may be positioning themselves for a takeover.

Q: Pfizer (PFE ) and Merck (MRK ) -- are they a hold, sell, or buy? Where do you think PFE will be in 12 months?


We have an accumulate on Pfizer. We expect Pfizer to be trading higher in 12 months, perhaps 25% to 30% higher. We maintain a hold on Merck as a market performer. Merck should perform in line with the market.

Q: GlaxoSmithKline (GSK ) has been hanging right in there, and their pipeline looks good. What do think of them?


The problem with Glaxo is that they're facing some generic competition in their biggest lines. That includes Augmentin (antibiotic) and Paxil (antidepressant) -- two of their biggest drugs. The generic threads will be litigated by Glaxo, and we cannot determine the outcome of this litigation. Glaxo does have a strong pipeline of new drugs -- they should launch 13 major drugs over the next three years.

Q: What's your opinion on Andrx (ADRX ) after the ruling on Prilosec?


The ruling, of course, was a major setback. On the other hand, ADRX is the only company that has an FDA-approved generic Prilosec. Therefore, we think that ADRX might do a deal with Schwarz Pharma AG, whose generic Prilosec was found not to infringe on the branded patent held by AstraZeneca (AZN ). If ADRX agrees to waive their rights of first launch, then Schwarz would be able then to launch their own generic Prilosece.

Q: What are your expectations for AZN and NVS (Novartis)?


AZN, of course, will be an obvious beneficiary in the Prilosec patent ruling, which was in their favor. Also, they have a number of other products in the pipeline that are very promising for future growth. Some of those products include Crestor (cholesterol) and Iressa (anticancer) -- they are both very promising products. Novartis also has a very decent new drug pipeline. They recently got a favorable decision from the FDA on their Zelnorm treatment. They also have a new pain drug called Prexig -- another promising one. And they're also a leader in generics. So I think they're doing O.K.

Q: Do you think Forest Labs (FRX ) can continue to do well?


Forest Labs has been the best-performing stock in my group. And that reflects growth of Celexa (anti-depressant) and the recently launched second-generation Celexa called Lexa Pro. They also have a promising new drug for Alzheimer's disease.... We maintain an accumulate on the Forest Labs shares.

Q: Frank, are there any names ranked buy among the biotechs you cover?


We have buys -- one on Cephalon (CPH ) and one on Gilead Sciences (GILD ). What I would say about those two companies is that they're both characterized by rapid revenue growth that should continue over the next several years. And they also both have diversified portfolios of FDA-approved drugs. Cephalon's main growth drivers will be Provigil (to treat daytime sleepiness) and Actiq (to treat cancer pain). Gilead Sciences' main growth drivers will be Viread to treat HIV and Hepsera to treat hepatitis-B. Based on the growth we foresee, we feel that the shares of both are reasonably priced.

Q: Herman, what about among big pharmaceutical stocks? Any ranked a buy?


We have no buys among the top pharma stocks. But we do have accumulates on Pfizer, Wyeth (WYE ), and Aventis (AVE ). Also...on Johnson & Johnson (JNJ ).

Q: How do you value Elan's (ELN ) pipeline?


ELN is a company I used to cover. I dropped coverage a few weeks ago because the stock is down 98% and they remain entangled by very serious legal, accounting, and financial issues.

Q: Do either of you see big mergers in the near term?


We're going to see the completion of the Pfizer-Pharmacia merger. After that, there will be only about a dozen major pharma companies. The list of potential candidates has narrowed, but that doesn't mean that more deals can't happen. There may be a few more, but that's about it.

DiLorenzo: I don't see any major deals occurring over the next several months -- maybe some smaller deals, but no big blockbuster deals.

Q: Herman, can you comment on Eli Lilly (LLY )? What's your take on this company?


Eli Lilly is in the midst of a major FDA critique of their manufacturing facilities and delays in resolving those problems, which in turn is preventing new product approvals. This has been weighing on the stock. On the other hand, if they are successful in cleaning up these issues, the stock will have a good recovery from here.

Q: What about ICOS (ICOS )?


We have a hold on the company. It's a good firm, and they have a promising pipeline, but two issues I have with the company keep me from recommending it. One is that the company's cash-burn rate is very high. They do have a good cash balance, so they should be able to move toward some profitability, but there are some questions over Cialis. Cialis could potentially be approved by the FDA next year. However, Pfizer filed a lawsuit to protect its Viagra drug against potential competitors such as ICOS. These lawsuits can be very costly and can take some time -- so there is some concern there.

Q: How about Biogen (BGEN )? It's been beaten down quite a bit. Any potential with this stock?


Well, that's a stock that I think is reasonably priced at current levels -- we have a hold on it. My main concern there is Avonex, a treatment for MS. It's facing competition from Rebif -- I think that as a result, there will be little if any growth for Avonex over the next few years.

Q: What advice would you two leave us about investing in pharmas and biotechs at this stage of the market?


Pharma remains strong and viable despite the economy. We do see eventual recovery in this group, which would be fueled mainly by new drugs that are likely to come down the pike within the next few years.

DiLorenzo: I would focus on biotechs that have sustainable, ongoing profitability and are projected to have high rates of growth in both revenues and earnings over the next few years. I think some of the nonprofitable emerging names are still very risky.

Edited by Jack Dierdorff

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