By Peter Lowden
Competitive and regulatory headwinds that have plagued the pharmaceutical industry continue for the large pharmaceutical companies, but the fortunes of the better established and well managed companies are starting to change. These companies have survived a difficult decade, and many are in good financial health, inexpensive, and full of new opportunities.
Pfizer (PFE) – With the market down a bit in the trailing 12 months, PFE is up 6%, and is also outpacing the overall healthcare sector’s performance for the same period. Much of this outperformance has come recently, however, which might be an indication that PFE is being accumulated by investors. PFE has significantly underperformed both the market and the healthcare sector the last decade due to issues with its products and its management that have produced flat performance for the world’s largest drug company. The company continues to face challenges, such as the patent expiration next month of its largest drug, Lipitor. However, with this significant event finally here, investors may now be starting to focus on PFE’s bright future. Management has done a good job of cutting costs and building relationships in emerging and other growth markets. However, the real attraction is likely the 25 new drugs in late stage clinical trials that should boost earnings. PFE sports an attractive 4.3% dividend, but a high dividend payout ratio. We think that PFE’s recent outperformance combined with its bright future products and high dividend make for a potentially appealing investment for longer-term investors, and should be watched closely for confirmation.
Abbott Labs (ABT) – Like many companies in the healthcare sector, ABT has been outperforming the overall stock market with the increase in market volatility. However, the company has the characteristics that could see it continue this trend even with a better performing stock market. ABT management has done an excellent job of positioning the company in growth markets, and improving efficiency through cost cutting. Unlike many of its peers that are purely pharmaceutical companies, ABT is a diversified healthcare company that is well situated to serve the growing baby boomer generation here in the U.S. as well as new markets overseas. These diverse and growing markets directly translate to ABT’s attractive, double-digit growth rate. Compared to its P/E ratio of approximately 16 times earnings, ABT’s growth to P/E (PEG ratio) is a reasonable 1.25. ABT also sports an attractive, market beating dividend yield of 3.7% and a reasonable dividend payout ratio of 55%. Given its geographical as well as product diversification, relatively high growth rate, reasonable valuation, and quality management, we think ABT should be owned by longer-term investors. Current prices are an opportunity to start to accumulate shares for those that do not current have a position.
Sanofi Adventis (SNY) – SNY stock is down about 2% for the trailing 12 month period, slightly underperforming the overall stock market and its industry peers during the period. While SNY underperformed significantly during the market’s run up earlier this year, it has not fallen as far with the market’s recent downturn. This performance, relatively flat compared to the market and its industry, reflects SNY’s near-term challenges stemming from its product mix and patent expiration calendar. While management has worked hard to cut costs and improve efficiency, it has also applied new strategies. To solve the problem and create more growth visibility, SNY acquired Genzyme (GENZ) last February to increase its exposure to higher growth biotechnology drugs. SNY management has said that the acquisition will start to produce results in 2012, which marks a new period where sales should start to grow again at an annual rate of 5%. However, we think investors should expect a timeline for this new growth to be implemented as SNY’s challenges will dominate the headlines for the company for the time being. SNY has a dividend yield of 4%, and a high dividend payout ratio. Given the many options for investors in the pharmaceutical space, we think there are more attractive investments for investors. We would watch SNY for now, and wait for confirmation of their growth strategy before investing.
Johnson & Johnson (JNJ) – JNJ stock is roughly flat for the trailing 12 months, in line with the overall stock market and the healthcare industry. However, the road taken by JNJ and the healthcare sector has been significantly different than that of the market. Like most defensive names, JNJ did not fully participate in the market’s run-up earlier this year, nor did it fully participate in its decline. This defensive profile is a product of its business, both good and bad. JNJ is one of the premier public companies in the world, with world-class management, consumer brands, and a pristine balance sheet that makes it the envy of corporate America. JNJ management has maximized the company’s opportunities so much that it is now so large and dominating in its markets that it has little future growth beyond its attractive dividend yield of 3.7%. This yield is of a quality that is hard to appreciate at face value, and is considered by some investors as a bond alternative. Because of its quality, dominance, and execution, JNJ is awarded a higher valuation than most companies with lower growth rates. This unique situation and resulting high valuation-to-growth ratio makes JNJ attractive only to very conservative investors that are either looking for strong defense in down markets, or high quality dividend income longer-term. For the rest of the investor community, we think there are other names that offer better growth without having to give up much in the way of quality.
Novartis (NVS) – NVS stock continues to underperform the overall market and the healthcare sector for the trailing 12 months, but is outperforming both indexes in the recent six month period. This timeframe analysis highlights a potential change in investor perception for NVS and its attractive characteristics relative to its competition. What plagues most of the industry, product patent expiration and regulatory approval risk, are significantly less present in this situation as NVS has a large pipeline of drugs in late stages of approval, as well as a large generic drug division. This division helps to smooth the uncertainty of its drug pipeline which is focused on high growth cancer treatments that can have higher revenue volatility. While NVS has an attractive 3.6% dividend yield, its valuation is even more attractive. NVS trades at roughly 10 times earnings estimates, and is projected to grow at an annual rate of 12%. The resulting PEG ratio (P/E to Growth rate) of less than 1 is compelling, especially when considering the quality of the company and the low volatility nature of the industry and this diversified name. Because of its product mix and growth prospects, we think NVS is one of the more attractive names in the pharmaceutical space. We recommend that longer-term investors consider adding NVS to their diversified portfolios.