Schering-Plough: Drugmaker, Heal Thyself


By Amy Tsao These days, investors are wondering what's next at Schering-Plough (SGP) -- and not without reason. So far in 2003, sales of allergy drug Claritin have dropped to less than $200 million, way down from almost $2 billion that they achieved in 2002, when patent protection expired in December. The outfit must also contend with pricing pressure on its money-spinning hepatitis C drug, regulatory probes into marketing practices, and federal regulators' demands that it clean up manufacturing procedures at a number of plants. "It's a can of worms," say Paul Abel, portfolio manager of Kinetics Medical Fund (MEDRX), who sold his stock nine months ago.

Many share Abel's view, and the share price reflects that disaffection. While pharmaceutical stocks have been flat over the past 12 months, Schering has declined 20% in the same period, to around $19. Nor is it cheap next to its peers, with a forward price-earnings ratio of 23, vs. Pfizer's 17. Meanwhile, 21 of 27 Wall Street analysts rate the stock neutral or lower.

Yet value investors are undeterred. They point out that Schering has a new CEO and a potential blockbuster drug on the horizon. "We like the strong free cash flow, and it's in an industry with growth prospects," says Rick Jones, director of value equity management at BB&T Asset Management. He admits that Schering, with $10.2 billion in 2002 sales, is expensive when judged by earnings. But he also points out that this year's dividend return of 68 cents helps to offset the high p-e. (Schering is a holding in BB&T's value portfolio.)

A VETERAN'S EXPERIENCE. Schering isn't for the faint of heart. And it also demands that investors believe industry veteran Fred Hassan, Pharmacia's former chief, can turn the drugmaker around. Hassan is credited with steering his former employer into a sea of black ink by increasing sales of drugs for glaucoma, incontinence, and arthritis. That turnaround was so successful that Pfizer (PFE) last summer bought Pharmacia for $60 billion.

Now, Hassan is CEO at Schering. In April, his first month on the job, he repudiated former earnings-per-share guidance for 2003 of 75 cents to 85 cents, declining to nominate a specific figure. He plans to update investors on his turnaround strategy on July 23, when Schering will announce second-quarter earnings. Says Jones: "That will give a pretty decent road map. He'll have a chance to get out all the bad news he knows about."

A prime focus for Hassan's attention will be clearing up Schering's legal uncertainties. Settling with federal and state investigators is a must if he's to assure investors. On May 30, the company announced that the U.S. Attorney's office in Boston had notified it of a federal grand jury looking into Schering's alleged sales of unapproved drugs and for allegedly paying doctors and insurers to steer patients toward its medications. And on May 14, Schering said it would bring into compliance four plants where the Food & Drug Administration (FDA) found "significant and widespread" production deficiencies.

CHOLESTEROL COCKTAIL. Shaojing Tong, drug analyst at Mehta Partners, figures the investigations can be resolved. And he's optimistic that fixing quality-control shortfalls at those manufacturing facilities could convince the FDA to approve Asmanex, an inhaled asthma medication that has been delayed for several years. Analysts believe Asmanex could be a $1 billion-a-year drug.

Better yet, Schering's cholesterol treatment, Zetia, which was approved by the FDA late in 2002, could be a winner. The approval cleared it as an add-on treatment for patients who either can't tolerate the so-called statins, the standard therapy, or who have failed to achieve the desired results from high doses. By itself, Zetia is no blockbuster, however. In its first full quarter on the market, worldwide sales totaled just $46 million.

While that figure is insignificant in itself, a pill comprising Merck's (MRK) Zocor and Zetia has Wall Street excited. The combined medication, which will be filed for FDA review later this year, has the "potential to be bigger than Claritin ever was," says Schering spokesman Bob Consalvo. If approved, the combo might begin to add some needed heft to the top line sometime in 2004.

PILL PARTNERS. The two-pronged method of lowering cholesterol represents a "new way of thinking," says Dr. Matthew Sorrentino, associate professor of medicine at the University of Chicago. Zocor, which is a statin, works by stopping the liver from turning fat into cholesterol, while Zetia inhibits cholesterol from being absorbed in the intestine. If priced competitively, the single pill could be popular, Sorrentino figures, since patients who have to take more than one anticholesterol drug would find it more convenient.

Some analysts project at least $2 billion in peak annual sales for the combined pill, but Mehta Partners' Tong figures sales could reach $4 billion to $5 billion in 2007. That compares to $8 billion in 2002 sales of Pfizer's Lipitor, now the biggest anticholesterol drug on the market. Steve Paspal, senior research analyst at Sovereign Asset Management, sees Schering's stock as "pretty intriguing," based on Zetia's long-term prospects. (Sovereign is a subsidiary of John Hancock Funds. Paspal says Sovereign doesn't own the stock.)

Merck and Schering, which would split revenues from the combo, can be expected to devote considerable resources to convincing doctors that the Zetia-Zocor cocktail represents an improvement over statins alone. That, however, could be a tall order, as most patients haven't had significant problems with existing therapies. "Clinically, dosing is not a big issue, given that people have been pretty satisfied with currently available statins," says Tong, who is quick to add: "We think Merck will do everything it can to convert Zocor users to the combo."

Since the drug is critical for both Schering and Merck, such a promotional effort is all but certain. For Schering, it would make up for Claritin's plunging sales. For Merck, the new pill could help extend patent life for Zocor, a $5.6 billion product.

HEPATITIS C PRESSURE. To persuade doctors, the prospective partners might cite recent history. The amount of Zocor will be lower in the combined pill -- something that may well persuade doctors to switch their patients, given that, in 2001, a statin made by German drugmaker Bayer (BAY) and sold under the name Baycol was linked to several deaths. Other patients experienced severe muscle problems, a more common problem associated with higher doses of all statins.

Schering is also seeing pressure on its hepatitis C franchise, its largest revenue generator. Sales of combo therapy ribavirin and Peg-intron fell 7% in the first quarter, to $516 million, as a competing product by Roche Holding gained market share. Generic-drug makers are another looming threat, and Schering's 2003 sales will be hurt by competition, says Tong, who nevertheless expects long-term demand for hepatitis C treatments to remain strong. He expects Schering's slice of the market to remain "a cash cow," even though, by 2008, he anticipates sales will amount to only $2.5 billion, down from the $2.7 billion they achieved in 2002.

Still, many continue to see Schering is a high-risk prospect. More cautious investors probably will want to wait for the stock to retreat further, to $17 or below, wrote CIBC World Markets analyst Mara Goldstein in a May 30 research note. "The shares can be compelling for investors with high risk-reward profiles and longer-term investment horizons," she wrote. (CIBC received banking fees from Schering in the past year.)

Given the current uncertainties, the stock's current price reflects the hope that Schering's foray into the $16 billion-and-growing cholesterol market will pan out. Investors who can stomach the near-term uncertainties should listen closely to CEO Hassan's progress reports at upcoming analyst and investor meetings. While Schering isn't without risks, it has a decent shot at a comeback. Tsao covers financial markets for BusinessWeek Online in New York


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