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SECTOR SCOPE by James A. Anderson April 26, 1999

Birth of a New Sector: Life Sciences
Why the likes of Dow, DuPont, and Monsanto are the Street's newest buzz stocks

Start with a chemical stock -- shares of a company whose business is cyclical and whose earnings seldom grow at an eye-popping rate. For good measure, make sure the stock is susceptible to busts in overseas markets such as Asia. Add to the mixture a biotech lab or gene-splicing unit that's working on new-fangled seeds and plants that ward off fungi or insects. What you'll end up with, most likely, is a stock in what Wall Street has started to call a "life-sciences company," a hybrid straddling the worlds of agribiotechnology and ordinary farm products such as seeds and feed.

Youíll also have a stock with buzz. When it was a chemical stock, it traded at a discount to the market. Now that it's a life-sciences stock, it can command prices of 40 to 50 times projected earnings. "The label life science is to the chemical industry what dot.com is to technology stocks," says Standard & Poorís analyst Richard OíReilly. "Add that name, and it seems youíll get a premium to the market in no time."

Monsanto Co. (MTC) is a good example. The closest thing there is to a life-sciences pure play, it spun off its chemical operations in September, 1997, spent $8 billion in seed and biotech companies and went off to tinker with the DNA of plants. Now, it's true that Monsanto is down 2% this year, to 46 and change, even after a $4 run-up on Apr. 23, while chemical oldies such as Dow and DuPont have done much better, rising 26% and 25%, respectively. In part, though, that's because the traditional chemical group looked undervalued compared with the economy.

RARIFIED SPACE. Another way to look at Monsanto's current status is that its shares hover at 50 times Wall Street consensus 1999 earnings estimates of 84 cents a share as compiled by Zacks Investment Research. Thatís rarified space normally reserved for biotech shares, which historically have averaged a p-e ratio of 34, vs. the 18 or so multiple allotted plastics and chemicals companies.

Does this mean that investors should keep their noses out of the greenhouse? Not necessarily. For instance, DuPont's decision to snap up the 80% of agribiotech player Pioneer Hybrid it doesnít already own in a $7.7 billion deal and Dowís stated intent to increase its presence in that burgeoning market might also be factors in the rally of those two stocks. And Monsantoís latest earnings, announced on Apr. 22, may foreshadow good things ahead for life-science companies. While profits for the quarter fell 12 cents, to 20 cents a share, from a year earlier because of the earnings dilution from recent acquisitions, sales rose to $2.5 billion for the quarter, up 25% from a year ago.

One highlight: The company's arthritis pain drug, Celebrex, is off to perhaps the most rousing start of any pharmaceutical product ever with sales of $279 million from its launch in mid-February to the end of the first quarter -- and while there are now reports that Celebrex might have caused 10 deaths among the 250,000 patients who have used it, both the company and analysts are downplaying the significance of the news. Monsanto also reported that sales of agricultural products, the source of roughly 50% of its revenues, rose 31% for the quarter, vs. a year earlier. That segment of the companyís business includes strains of soybeans and cotton genetically engineered to withstand herbicides, pesticides, or even ward off legions of beetles and weevils.

SOYBEAN MASTER. The ag unit's performance is a key indicator for the company's life-sciences group, which is anchored in agribiotechnology. Itís also telling that since their introduction in 1996, soybean seeds developed on Monsanto's designs have gone from zero to capture a 30% share of the overall domestic market, while its cotton strains have captured a 45% share. That includes insect-resistant varieties as well as brands that are resistant to Monsantoís line of Roundup herbicides.

The future could be even brighter. By 2000, Standard & Poor's analyst Robert Izmirlian estimates that 40% to 60% of the seeds solid in the U.S. will be genetically enhanced. And portfolio manager Christopher Bonavico of Transamerica Premier Value Fund thinks thatís just the beginning. He says Monsanto and DuPont, now that the latter has swallowed Pioneer Hybrid, have locked up the sweet spot of agribiotech. "Itís a situation thatís analogous to Intel, which sets the tone for the computer industry and has software companies writing programs to fit its architecture."

The comparison is all the more appropriate now that the industry is branching out from crops that are merely pesticide- and herbicide-resistant to designer plants -- ones that have specific traits for specific markets. Their characteristics range from heightened protein levels for soybeans earmarked for cattle feed to specific colors for various strains of cotton. Salomon Smith Barney analyst James H. Wilbur puts the current market for engineered plants at perhaps $6 billion a year, a sign that the new industry is starting to cut a groove into the $30 billion global market for crop chemicals including pesticides and herbicides, the very products genetically enhanced seeds could soon push aside. And, as agribiotechnology expands to include specialty plants, the market could grow to as much as $20 billion in 10 years, Wilbur says.

NICE RUN AHEAD? No doubt, obstacles are ahead. For instance, explicit labeling for food processed from genetically altered grains or for meat from animals fed on gene-spliced meal, is a big issue in Europe. But analysts point to market acceptance of such products in spots as far flung as China and South Africa as proof that agribiotechnology has a bright future.

As for agribiotech, Monsanto is the new groupís obvious bellwether. And if its Apr. 22 earnings report is an indication, the stock could be in for a nice run. Salomon Smith Barneyís Wilbur raised his 1999 earnings estimate for the company to 96 cents a share from 85 cents. He thinks the stock could rise to $55 within 12 months. Currently, according to calculations by First Call, a company that tracks analystsí projections, the consensus Street recommendation for Monsanto is a strong buy, and analysts look for the company's earnings to grow an average 22% annually over the next five years.

Even after a huge rally so far this year, DuPont might also warrant a look. It's still bound to its traditional chemical business, but that isn't a deterrent to value investors such as Randall Eley of Edgar Lomax Co., a money management firm in Springfield, Va. "Even though DuPont remains largely a commodity producer, the company has taken drastic steps to cut costs and to move into new businesses," says Eley. "So when the chemical companies regain pricing leverage, youíll see more go straight to DuPontís bottom line." Most analysts rate DuPont a buy and look for the company's earnings to grow an average 9% annually over the next five years.

If youíre looking for a life-sciences mutual funds, the news isn't good: There arenít any. The closest to a sector-specific fund in Morningstarís portfolio screens is Dresdner RCM Global Health Care Fund (DGHCX), which has a 5.6% weighting in Monsanto. The fund posted a total return of 25.57% last year but so far this year is down 4.47%. But if the life-sciences sector keeps growing, chances are that funds looking to grow with it will soon start sprouting.

James Anderson, who teaches journalism for the City University of New York, writes Sector Scope every other week

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