By Bill Alpert
ealth-care stocks have been behaving in an unusually unpredictable manner in the 1990s. They were famously knocked for a loop by fears of nationalized medicine in the first Clinton Administration. Then they were further depressed by worries about patents that were expiring on various best-selling drugs like Merck's Vasotec and Glaxo-Wellcome's Zantac. Most recently, the group has been revived by Pfizer's Viagra, the impotence drug that's become famous as a punchline on late-night TV.
Before long, investors may find yet another reason to warm to health-care stocks. With the economy and the stock market showing signs of stalling, what better place to put your money than in an industry that does well in good times and bad? Health, after all, knows no business cycles.
That helps explain why drug stocks have been among the star performers so far this year, rising 18% on average. New medical devices have also excited the market, none more so than Guidant's new generation of artery-expanding stents, which should bring the company $500 million in sales this year.
Mergers have played a role, too. Witness the stock action that followed United HealthCare's /zigman2/quotes/210453738/composite UNH +1.00% recent decision to join forces with Humana /zigman2/quotes/203095337/composite HUM +1.29% , or Monsanto's union with American Home Products .
All the news is not good, however. While many health-care providers are successfully resisting the pressure to cut prices on their goods and services, one exception is likely to be the nursing-home industry. The stocks in this sector have been depressed, in large part because, starting this autumn, nursing homes will have to operate under the kind of fixed-payment regime Medicare imposed on hospitals more than a decade ago. The impact of this change is hard to predict on a company-by-company basis. But clearly, investors are standing on the sidelines until nursing homes show what kind of profits they can earn under the new system.
Not every drug stock has done well, either. Merck and Schering-Plough have lost luster in the eyes of investors who see few new drugs coming along to boost those firms' profits. Indeed, Schering's only blockbuster drug is Claritin, an antihistamine with a patent that expires in five years. As usual, the drug stocks that have helped investors most have been the ones with the strongest products, says analyst Paul A. Brooke, of Morgan Stanley Dean Witter. Looking ahead, Brooke sees performance remaining individualistic.
Brooke says that one of the best-performing stocks, Pfizer /zigman2/quotes/202877789/composite PFE -0.52% , may have upside potential even at its recent price of $104, or 38 times '99 earnings estimates of $2.70 a share. Pfizer continues to see strong sales growth for its billion-dollar antidepressant, Zoloft, and its antibiotic Trovan recently got the FDA's blessing for use against a broad spectrum of germs. Viagra can't be ignored, either. Today's stock price suggests that investors see annual sales of Viagra topping out at between $2.5 and $3 billion a few years from now, but Brooke thinks the pill's opportunity is greater still.
One of Brooke's favorite stocks is Eli Lilly /zigman2/quotes/200106384/composite LLY +1.11% . The Indianapolis firm's prospects had seemed clouded by the expiration of its U.S. patent on Prozac in 2003. But some recent studies of a new Prozac formulation raise hopes that the antidepressant may find extended patent life. The studies show that a combination of Prozac and the Lilly antipsychotic Zyprexa appears to lift depression in many patients for whom drugs like Prozac by themselves haven't worked. This combination has been shown to work on patients who have refractory depression, and this group may account for up to 25% of all depressed souls. So if the combination treatment proves out, says Brooke, it may reach the market around the time of Prozac's patent expiration.
A more exciting dose of new revenues for Lilly will come from its new osteoporosis drug, Evista, launched in January of this year. Recent studies show that Evista doesn't aggravate breast cancer risk, as do other osteoporosis drugs. To that claim, Lilly may eventually be able to add the boast that Evista reduces risk of heart disease. Within five years, Brooke estimates, Evista could be nearly a $3 billion product for Lilly.
These developments could boost the earnings multiple of the $62 stock, says the Morgan Stanley analyst, above its current level of 27 times his 1999 estimate of $2.25 a share. ''The psychology is clearly bottoming out,'' says Brooke. ''And the issue is not the numbers, it's the psychology.''
Merck is the big drug company favored by Arnold H. Snider, general partner of Deerfield Management. Snider and his New York City crew manage about a half-billion dollars in hedge-fund money, all dedicated to health-care stocks. Sad to say, Snider's fund is closed to new money. Net of fees, the fund has averaged annual returns of 28.6% for the past four years. Snider believes the share prices of outstanding outfits like Pfizer or Warner-Lambert have already taken into account the firms' growth prospects. And many other stocks, especially those of British and Swiss drug companies, are a bit overpriced in light of the pathetic sales growth the companies are showing.
The only big name Snider cares for is Merck. He points out that Merck has the lowest price-to-earnings multiple in the group: At $114, its shares trade for 22 times 1999 estimates of $5.15. Despite growing sales of Merck drugs like Fosamax, for osteoporosis, and Zocor, for cholesterol, investors worry about patents that are slated to expire in the coming few years on such key Merck heart drugs as Vasotec, Prinivil and Mevacor. But Snider says that three new products could keep up Merck's momentum. They are Singulaire, a new asthma drug; Maxalt, a migraine drug, and Vioxx, a new kind of arthritis drug that won't upset stomachs. ''Our sense from talking to physicians,'' says Snider, ''is that all three of those drugs will be blockbusters.''
The hedge fund manager's unease with European drug makers is aggravated by two major issues. Pricing for any drug has tended to vary across Europe, with Northern European countries reimbursing makers at higher prices than Southern European countries do. But with a single European currency next year, wholesalers will find it easier to move drugs from the cheaper nations to the expensive ones, making it tough for drug makers to keep a price cut in one country from rippling across Europe. Snider's other concern is that Year 2000 software problems (caused when the millennium flummoxes computers that track only the last two digits of a calendar year) will be much worse in Europe than in the U.S. Nations with socialized medicine may find themselves particularly snarled up, making it hard for drug makers to collect their receivables.
Glaxo-Wellcome is the kind of Euro drug stock whose valuation puzzles Snider. Glaxo's Zantac, an ulcer drug, is history now that its patent has expired, and across the rest of Glaxo's product line, rival drugs are swarming: New AIDS antivirals from the likes of Agouron Pharmaceuticals, Bristol-Myers Squibb /zigman2/quotes/202559280/composite BMY -0.22% and Merck have grabbed share from Glaxo's Retrovir; a raft of faster-acting migraine drugs will soon bite into the business now done by Glaxo's Imitrex, and Glaxo's asthma franchise has but one strong grower, named Flovent. Glaxo's earnings in the first half of '98 will be down by 15%-20% from year-earlier levels, says Snider, yet Glaxo shares remain pricey.
The money manager is more enamored of small drug stocks. One smaller firm with the potential to more than double its size, says Snider, is Forest Laboratories . The company will launch an antidepressant drug called Celexa this summer. Warner-Lambert will help market Celexa, whose claim to fame is that it has fewer harmful interactions with other drugs than does Prozac. That may make Celexa a more palatable drug for the elderly, says Snider. Forest Labs shares trade around $33, which amounts to 34 times expected earnings for the fiscal year ending next March.
A biotech favorite of Snider's is Centocor , whose clot-preventing drug ReoPro looks better with each new study. In the first quarter, Centocor presented results of a trial involving 2,400 patients with blocked heart arteries, each of whom underwent coronary stenting or balloon angioplasty. There were 54% fewer deaths among patients who were given ReoPro and a stent than among those who were given a placebo and a stent.
Even the FDA approval of rival products from COR Therapeutics and Merck /zigman2/quotes/209956077/composite MRK +0.20% doesn't dim Snider's enthusiasm for ReoPro. In just 10 minutes, he says, the Centocor product can cool down about 97% of patients who show up at an emergency room with dangerous angina, while the COR and Merck products take longer to kick in, and even then they help only about half of such patients.
With Lilly handling ReoPro's marketing, ReoPro's sales grew 35% in the quarter ended in March of this year, to $70 million. With the drug selling for more than $1,000 a shot, and a couple of million new heart-disease patients showing up every year, there's enough opportunity to leave investors comfortable even though the stock, at a recent 36, is trading at 40 times next year's expected earnings.
And Centocor has another ace in the hole. Last month, a panel of FDA advisers urged approval of the company's Avakine product. If approved, Avakine might sell for $5,000 a year to a good portion of the 250,000 Americans who suffer from the severe intestinal ulcers known as Crohn's disease.