Life Sciences: Positive Results

S&P's top picks among companies that serve the pharmaceutical and biotech industries: Covance and Thermo Fisher Scientific

By Sam Stovall From Standard & Poor's Equity Research

S&P 1500 Life Sciences Tools & Services Index vs. the S&P 1500

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This week, the S&P 1500 Life Sciences Tools & Services subindustry index was added to the high-momentum list, which consists of those S&P 1500 subindustry indexes whose trailing 12-month price performance ranks in the top 10% of all subindustries in the S&P 1500 index. Year-to-date through July 18, 2008, this subindustry index was down 6.0%, vs. a 13.3% decline for the S&P 1500 index. During 2007, the subindustry rose 30.8%, compared with a 3.6% advance for the 1500. The group was added to the S&P 1500 Composite 1500 Index in April 2006 and has been outperforming the broader market on a rolling 12-month basis since April 2007.

There are 18 large-cap companies in the S&P 1500 Life Sciences Tools & Services subindustry index, 11 of which are covered analytically by S&P equity analysts. Of those companies, six are ranked a buy or a strong buy: Charles River Labs (CRL; buy; 63), Covance (CVD; strong buy; 88), Invitrogen (IVGN; buy; 40), PerkinElmer (PKI; buy; 28), Pharmaceutical Product Development (PPDI; buy; 40), and Thermo Fisher Scientific (TMO; strong buy; 56). Two nonindex companies also have favorable investment opinions: Exelixis (EXEL; buy; 6) and ICON (ICLR; strong buy; 76).

In the accompanying chart, the jagged blue line represents the subindustry index's rolling 52-week price performance, compared with the 52-week performance for the S&P 1500. Any point above 100 indicates market outperformance over the prior year, while points below 100 indicate market underperformance. The red line is a rolling 39-week moving average, while the two green bands indicate one standard deviation above and below the index's long-term mean relative strength.

Jeff Loo follows these stocks for S&P Equity Research. He has a positive fundamental outlook for the life sciences tools and services subindustry, based on his continued favorable view of the contract research organization group and stable growth for life science consumables. He expects equipment sales to moderate a bit in 2008, however, following robust growth in 2007.

The life sciences industry depends on pharmaceutical and biotechnology spending for research and development and on worldwide government funding, Loo says. He foresees high-single-digit increases in R&D spending balanced against soft worldwide government funding, which he thinks will temper overall sales growth. In the U.S., he continues to anticipate limited increases in the National Institutes of Health budget over the next several years. The 2008 NIH budget will increase only 1%, to $29.5 billion.

Companies within this subindustry derive revenue from the sale of equipment, consumables, and services. Equipment sales improved in 2007, following sluggish years in 2005 and 2006, and he expects sales to continue to be solid in 2008, albeit at a slower growth rate, as pharmaceutical end-users upgrade equipment and purchase innovative new products.

Purchases of consumables are typically immune from budget constraints. Therefore, Loo believes companies whose revenue bases primarily comprise consumables will likely grow faster than equipment manufacturers. Consumables also typically carry higher profit margins than instruments, and equipment manufacturers are aggressively expanding product lines to increase their sales of consumables. He sees consumable sales rising in the high single digits.