Today's Market: Big Pharma Vs. Big Biotech

by: Matthew Smith

Today we have a tale of two drug companies which released quarterly results and further highlight the new and old guards within the overall sector. We have watched for years as the "Big Pharma" companies have grown stagnant and resorted to financial gamesmanship to boost the numbers and bottom line growth, but with patent expiration beginning to hit and the pipelines pretty much dry investors are beginning to see the real stars in the drug business shine, the biotechs.

We get asked a lot whether one should seek growth companies out or those offering healthy yields when it comes to the pharmaceuticals and we always have to say it depends. We like some names within the "Big Pharma" realm but recognize that as an industry one has to like the biotechs much more due to their ability in recent years to crank out effective drugs which better target diseases. Big Pharma has really dropped the ball here outside of a few names, in our opinion.

Merck's (NYSE:MRK) earnings today were pretty disappointing and the press release read much like the rest of their peer group's did when they missed. The company saw top line numbers come in light versus the consensus from analysts while the bottom line beat but only due to cost cutting. This practice has worked for years, but the layoffs are taking a toll, especially as the brainpower walking out the door goes smaller competitors creating the drugs of tomorrow. Most of the issues for Merck were caused by its big diabetes drug Januvia seeing a decline in sales, which is further evidence that the newer drugs on the market from competitors are gaining traction and whittling away at Januvia's market share. Worse still is that the animal products segment posted disappointing results as fears about key products there led to lower sales. When the best thing that the talking heads can say after you report is something along the lines of well at least we have the conference call to see if they will break up the company to realize greater value, investors know that the company is focusing on the wrong issues. These companies need to be reinvesting these cash flows in R&D to prop up their ailing pipelines and/or buying more biotech names to add to their portfolios.

Investors have to be disappointed with a flat year when the market is up over 20%. That is severe underperformance, but the quarterly report (located here) backs this action up.

(Click to enlarge)

Source: Yahoo Finance

Why do we feel this way? Simply look at Biogen Idec (NASDAQ:BIIB) which saw its shares pop this morning in pre-market trading after their earnings announcement (located here). The company not only beat for the quarter but also increased their 2013 guidance as their MS drug exceeded sales forecasts for the quarter ended. The good news simply continues for shareholders here as Tecfidera sales are outpacing expectations which could indicate that the drug will reach the $3.5 billion level many expect before 2016. This drug is going to more than triple in size over the next few years and be a key driver for growth along with the rest of Biogen's stable of MS drugs. Whereas names like Merck are growing by cutting, the biotechs are growing by spending and investing heavily in their businesses. We would expect the transition of investor capital that seeks capital gains to continue rotating out of the slow growth "Big Pharma" names and into the biotech names over the next few years, or at least until "Big Pharma" begins to invest heavily in their pipelines again.

Chart of the Day:

The past two years has seen the biotechs strongly outperform the big pharmaceutical companies as measured by the SPDR Pharmaceutical ETF (NYSEARCA:XPH) and the Nasdaq Biotech Index. We believe that this is the beginning of a bigger trend which will see "Big Pharma" have to buy more biotech names in order to remain relevant and keep from going the way of the dinosaurs.

(Click to enlarge)

Source: Yahoo Finance

We have economic news today and it is as follows:

  • Industrial Production (9:15 a.m. EST): Est: 0.3% Actual: 0.6%
  • Capacity Utilization (9:15 a.m. EST): Est: 78.0% Actual: 78.3%
  • Pending Home Sales (10:00 a.m. EST): Est: -1.3% Actual: -5.6%

Asian markets finished higher today:

  • All Ordinaries -- up 0.96%
  • Shanghai Composite -- up 0.04%
  • Nikkei 225 -- up 2.19%
  • NZSE 50 -- up 0.59%
  • Seoul Composite -- up 0.68%

In Europe, markets are trading lower this morning:

  • CAC 40 -- down 0.75%
  • DAX -- down 0.18%
  • FTSE 100 -- down 0.16%
  • OSE -- down 0.44%

Big Pharma Has Winners And Losers Too...

We want to be clear with readers though that we are not altering our view on Johnson & Johnson (NYSE:JNJ) though. This is a well diversified name which has added to its OTC brands over the years and built steady cash flows from that business while reinvesting in a pharmaceutical business which is at the top of the pack when evaluating these businesses. The kicker right now is the medical devices business, which may see a spin-out or sale in the coming months as the company looks to focus its efforts more towards drugs. Johnson & Johnson has been one of the best performers in the Dow this year and historically has had solid, steady growth numbers. We are bullish this name heading forward and it is due to the underlying business, drug pipeline and strong dividend policy - not because of a potential separation of the medical devices business.

The stock has moved sideways in recent months, but we still think it is a candidate to take out $100/share by the end of the year, especially if the market remains strong and our leaders in Washington can get their act together and not drop the ball once again.

(Click to enlarge)

Source: Yahoo Finance

Whereas Johnson & Johnson is one of the few winners we see in the industry, Pfizer (NYSE:PFE) kind of scares us at this point. The stock has benefited from management's expertise in capital allocation and using financial engineering to boost the share price via sales of businesses, spin outs and cost cutting. Hurt in the process has been R&D in our opinion. The company has gotten into a habit, as we call it, of being a serial acquirer which has led to a corporate mentality of buy and then cut in order to boost returns and enable big share buy backs and dividend increases. The moves have worked thus far, but as patents expire where does that leave Pfizer in the long run? In our view it leaves them vulnerable and in need of acquisitions.

Whereas Big Biotechs Continue To Win, And Win Big ...

One would be wrong to assume that Biogen Idec is the exception when it comes to the Big Biotech names. In fact the entire sector is doing well, especially the names that have market capitalizations over $50 billion. Readers know that we have been bullish many of these names over the past year, with our favorite name having been Celgene (NASDAQ:CELG) as it gained momentum and broke through $100/share. It is one of the best performers in the S&P 500 this year with a stock that is up around 100% as investors seek the growth that its drug portfolio offer. Our view is that long-term one has to own the biotech names such as Celgene and Biogen Idec and that is why we are bullish on these names during pullbacks - the long-term outlook is just too positive to shy away from these names.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.