Markets & Finance

A Better Prognosis for Big Pharma


From Standard & Poor's RatingsDirect

Standard & Poor's Ratings Services have had an overall negative outlook on the U.S. pharmaceuticals industry for the past several years, given the many challenges facing the sector. These include generic competition, relatively bare new-product pipelines, the uncertainty of the Medicare drug benefit, and product-liability concerns, just to name a few. At the end of 2005, four of the eight major U.S.-based Big Pharma companies sported negative rating outlooks. In addition, a number of downgrades occurred in the 2002-2005 time period, including those on Merck (MRK), Bristol-Myers Squibb (BMY), and Schering-Plough (SGP).

Looking ahead to the rest of 2006 and 2007, however, Standard & Poor's believes that the outlook for Big Pharma credit ratings is improving. While the aforementioned concerns still certainly exist, recent key product launches, improving product pipelines, the relative absence of major drug-patent expirations over the intermediate term for several major players, and increased financial flexibility provided by the American Jobs Creation Act lead Standard & Poor's to believe that the negative pressures on ratings have lessened. So the three-year credit-ratings slide for Big Pharma may have subsided. This does not mean that ratings are going to be upgraded anytime soon, so much as that ratings appear to have generally stabilized at their current levels.

How do the major U.S. pharma players stack up? Here is S&P Ratings' company-by-company breakdown:

Abbott Laboratories

Rating: AA

The rating outlook on Abbott (ABT) is stable and is expected to remain as such, despite the additional borrowings needed to complete the acquisition of a vascular-products business from Boston Scientific (BSX). The company currently enjoys improving financial performance, strong free cash flows, and the benefits of new products, such as Humira. Over the intermediate term, Standard & Poor's expects Abbott to use its cash flows to steadily reduce borrowings that may be used to fund the vascular-products acquisition. In the unlikely event that the company accelerates share repurchases significantly or makes additional large acquisitions, the rating could be lowered.

Bristol-Myers Squibb

Rating: A+

Standard & Poor's recently reviewed the rating and negative outlook on Bristol-Myers, electing to leave both unchanged. We recognize the company's recent improvements, including settling its shareholder litigation, launching significant new products (such as Orencia), and settling its patent litigation on Plavix. However, we remain concerned over the loss of Pravachol sales and its impact on free cash flow, especially since current cash flows are inadequate to cover the company's hefty $2 billion annual dividend.

Eli Lilly

Rating: AA

Standard & Poor's currently has minimal concerns regarding the rating and outlook on Eli Lilly (LLY). The company has no major patent expirations for the balance of the decade, has one of the more productive pipelines in the industry, and has a strong financial profile, with limited future debt needs. Zyprexa continues to lose market share in the important U.S. market, and some of the newer, high-profile drugs, such as Cymbalta, have underperformed expectations. But Zyprexa losses are expected to be gradual, and Lilly has launched a number of new products over the past several years. The relatively well-stocked near-term pipeline is the more important issue and the main reason why the company has escaped the recent wave of Big Pharma rating downgrades.

Johnson & Johnson

Rating: AAA

Standard & Poor's has no concerns regarding the rating or outlook. Recent performance has been pressured and will continue to be pressured over the next few months owing to the loss of market exclusivity for several drugs. Still, the effects of these patent losses have been muted relative to nondiversified pharmaceutical firms. The diversity and leading market positions of Johnson & Johnson's (JNJ) high-margin health-care franchises enable the company to continue to generate above-market growth despite setbacks in several businesses. The copious cash flows in excess of ongoing needs that these businesses reliably generate provide the liquidity to continue to build on market-leading positions. In the meantime, Johnson & Johnson continues to maintain a very conservative financial profile, highlighted by a net-cash position of about $10 billion. Accordingly, it is very unlikely that the company's credit profile will weaken over the intermediate term.

Merck

Rating: AA-

The negative rating outlook on Merck is likely to persist over the intermediate term, reflecting the uncertainty relating to the company's Vioxx litigation and the concern regarding its ability to refresh its product portfolio over the longer term. Merck unexpectedly lost Vioxx in 2004, and is set to lose patent protection on Zocor in 2006, on Fosamax in 2008, on Cozaar/Hyzaar in 2010, and on Singulair in 2012. This punishing string of patent expirations -- a $3 billion-plus product every other year -- puts a large amount of pressure on Merck's R&D program.

Meanwhile, the Vioxx litigation results have been mixed thus far. Merck has won a number of cases, but has also lost a number of seemingly winnable cases, suffering significant damage verdicts. It is appealing these cases, so Vioxx-related cash outflows have thus far been largely limited to legal fees. Standard & Poor's has already incorporated the possibility of a significant loss due to the Vioxx litigation into the credit rating. Currently, it does not appear that there is significant pressure for a further rating downgrade due only to the litigation. The combination of patent losses, an unproductive R&D pipeline, and the litigation uncertainty are what drive the negative outlook.

Pfizer

Rating: AAA

There are no current concerns regarding the rating or outlook. However, Pfizer (PFE) is growth-challenged for 2006-2007. The company has suffered a number of major drug-patent expirations (Neurontin, Zithromax) and is due to experience more (Zoloft, Norvasc). Still, Pfizer has one of the best near-term product pipelines in the industry in terms of high-sales-potential prospects, has recently received approval on a number of prospects (including Sutent and Exubera), and is sitting on a large pile of U.S.-based cash. Pfizer is in the process of selling its consumer health-care business in a transaction that may further improve the company's cash balance.

Schering-Plough

Rating: A-

The rating outlook on Schering-Plough was revised to stable from negative on Mar. 24, 2006. Standard & Poor's believes that the rating slide since 2002 has ended. The Vytorin/Zetia franchise is generating strong sales and earnings growth. Though the launch of generic Zocor and Pravachol will likely slow the sales growth of Vytorin/Zetia, we believe the franchise will continue to generate solid growth given its unique position in the cholesterol-lowering market. Management has also stabilized the company and is expected to increasingly seek growth opportunities.

Schering-Plough was the only one of the U.S. Big Pharma companies to slash its dividends (a positive from a credit standpoint), conserving more cash to invest in its R&D program. The product pipeline still badly needs rebuilding, but with limited patent expirations and a growing Vytorin/Zetia franchise, it appears that the rating on Schering-Plough has bottomed out.

Wyeth

Rating: A

The outlook on Wyeth (WYE) was revised to stable from negative on May 3, 2006, owing to Standard & Poor's belief that the long-running diet-drug litigation challenges, while continuing, will not ultimately result in a cash outflow that will limit the company's financial and operational flexibility. Thus, the rating will increasingly reflect Wyeth's strong business risk profile, characterized by a diverse portfolio with significant exposure to biopharmaceuticals, minimal patent exposure over the next several years, and a rapidly maturing near-term product pipeline. Also, we believe that Wyeth, with its Prevnar vaccine and Enbrel -- two biopharmaceutical products that have minimal patent exposure and are still early in their product life cycles -- has one of the lowest sales exposures to Medicare Part D.


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