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DECEMBER 22, 2003
A Stimulant For Depressed Drug Stocks? For a bunch of can't-miss stocks, the big drugmakers sure did miss out on 2003's bull run. The dozen drug companies in the Standard & Poor's 500-stock index have returned 10% this year, vs. the index' 22%. You know why: failed drug trials, political blowback at high prices, generic rivals. Not long ago, Wall Street saw Big Pharma shares as a perfect portfolio complement to the fistfuls of (legal) pills being popped by baby boomers in their fogeyhood. Instead, they proved stone downers. None right now are more depressed than Johnson & Johnson (JNJ ), Merck (MRK ), and Schering-Plough (SGP ). Each has its specific reasons, naturally. Merck's shares, for example, suffer deep melancholia over the prospect of cholesterol blockbuster Zocor losing patent protection in 2006. But if you ask me, just as these stocks got way too cheap a decade ago under the threat of Hillarycare, so is the market now failing to credit the companies' strengths, especially clean balance sheets and research budgets that show they haven't lost their nerve. JOHNSON & JOHNSON. J&J is the most diversified of the three, with about half of sales from drugs and the balance from medical devices and consumer items. The knock on the stock has been that growth in sales will slow as such drugs as Procrit, an anemia medication, suffer competition. Yet J&J last year spent $2.7 billion, or 15.7% of pharmaceutical sales, on drug research, and it expects overall research outlays to grow faster than sales. So far this year, they're up 18%. J&J can do this easily because its balance sheet shows more cash than debt, while cash flow after capital spending and dividends through Sept. 30 was up 19%, to $3.5 billion, on sales of $30.6 billion. The stock trades under 17 times 2004 profit, which is seen rising 12%. MERCK. It once boasted the most bountiful new drug pipeline around. The stock, nearly septupling from a 1994 low, made legions of investors rich. Now, recent failures in trials of new drugs for depression and diabetes have investors fretting about life after Zocor. Some worry is legitimate. Yet it's also worth noting that Merck plows more than 13% of sales into research, or an estimated $3 billion this year. That budget has been growing faster than sales. Meantime, sales of Fosamax, its osteoporosis drug, and Singulair, used for asthma and allergies, keep growing nicely. S&P says that Merck is so strong financially, it could add $14 billion in debt and keep its AAA credit rating. The stock, with a 3.4% dividend yield, lately goes for less than 14 times 2004's estimated profit, which is seen growing at 7%. SCHERING-PLOUGH. In 2002, Schering signed a consent decree with the Food & Drug Administration over manufacturing problems. Worse, sales and profits fell this year and likely will again in 2004, thanks largely to the allergy medication Claritin going over the counter. That makes it financially iffier than J&J or Merck, but the balance sheet remains strong. Since CEO Fred Hassan, who led Pharmacia into its merger with Pfizer (PFE ), joined Schering in April, he has cut costs and the dividend, while refocusing on research and development. Despite lower revenue, R&D outlays rose this year to an estimated $1.5 billion, or over 17% of sales. Hassan has high hopes for Zetia, a cholesterol drug Schering and Merck are jointly selling on its own and, if regulators agree, in a combination therapy with Zocor. Hassan recently signaled his optimism by buying 303,500 shares, at an average cost of $15.42. Finding drugs and selling them profitably is dicey work. Some companies will do better than others. But how much better? Look at it this way: For $86, you can buy a share of high-flying biotech leader Genentech (DNA ), which I estimate will spend $1.57 or so a share on R&D in 2004. Or, you can pay just $50 for a share of J&J and see, say, $1.75 per share of R&D spending. Who can miss that value?  By Robert Barker
BW MALL
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