Big pharmaceutical firms are finally perking up
October 09, 2006

The pharmaceutical industry has looked wan and sickly in recent years. Loss of patent protection on many important prescription drugs, coupled with a dearth of new drugs coming out of research labs, has caused drug stocks to trail the overall market.

But now the sector appears to be returning to life. In the second quarter of 2006, all eight of the largest U.S.-based pharmaceutical companies beat Wall Street's earnings estimates. Four of the eight companies boosted profit forecasts for the rest of the year.

Several factors are working in Big Pharma's favor. Tens of millions of Americans have signed up for Medicare Part D, which began to stimulate drug purchases in the second quarter of this year, analysts say. Unlike companies in most industries, makers of branded drugs possess pricing power and are boosting pill prices by 5 percent or more. And don't forget demographic destiny: The ranks of seniors, by far the most prolific pill-poppers, are rapidly rising.

Trevor Polischuk, co-manager of Eaton Vance Worldwide Health Science fund, thinks Indianapolis-based Eli Lilly has the best growth prospects in the U.S. drug business today. Lilly spends an industry-leading 20 percent of sales on research and development. It has a $4 billion blockbuster in Zyprexa, the leading antipsychotic medication, and solid growth potential in recently unveiled drugs, including Cymbalta, a new antidepressant, and Cialis, a drug for erectile dysfunction.

Lilly is also a major player in diabetes treatments. It co-launched Byetta last year with a biotech company, has an inhaled insulin medication in late-stage clinical trials and has filed with the FDA for approval of Arxxant, the first treatment for diabetes-induced blindness. Incredibly, Lilly has no drugs going off patent the rest of this decade.

Polischuk is also bullish on Novartis AG. Like Lilly, Novartis has good sales growth from existing drugs, a robust drug pipeline and little exposure to patent expirations. Novartis's megahits include Diovan, a $4 billion hypertension fight

er, and Gleevec, an oncology drug that is prescribed for multiple cancer treatments. The investment case for Pfizer is different because it is more of a value play and turnaround story than an example of dynamic growth. Pfizer stock is cheap, selling at 14 times estimated 2006 earnings — well below the price-earnings ratio of both the industry and the overall stock market — and yields 3.6 percent. Expect the company under new chief executive Jeffrey Kindler to make nice with shareholders by aggressively buying back stock and raising the dividend later this year. So, shareholders will be paid to wait while scientists search for the next Lipitor, Pfizer $12 billion anti-cholesterol superstar.