Big pharma stocks have taken two hits in recent years. The first hit came from the prospect of the expiration of blockbuster drugs. The second hit came from proposed budgetary cuts for Medicaid and Medicare.
But judging from recent trading activity in the stocks of Pfizer (PFE), Bristol Mayer's Squibb (BMY), Abbott Laboratories (ABT), Eli Lily (LLY) and Merck (MRK), big pharma is back. But should investors buy into the rally?
Yes, for several reasons:
1. The market has already discounted the expiration of blockbuster drugs and Medicaid and Medicare budgetary cuts.
2. All five companies enjoy hefty profit margins, ranging from 21% to 34%, and with the exception of Eli Lily they do enjoy hefty earnings growth.
3. They all pay hefty dividends, ranging from 3.80% to 4.6%, compared to 1.88% for S&P 500 stocks (SPY).
Big pharma financial performance statistics in 2012:
Quarterly Earnings Growth
Quarterly Revenue Growth
4. A strong pipeline of new products, some of which have already gained FDA approval. Pfizer and Bristol Myers Squibb recently announced positive results on their blood thinner drug; Abbott reported positive results for a Hepatitis C Regimen; and Lilly reported positive results for its Metastatic Gastric Cancer drug; and its new Alzheimer's drug.
5. A slow growth world market environment that favors non-cyclical over cyclical stocks.
We particularly like Bristol-Myers Squibb, which has faced two setbacks in recent years. The first setback came from the prospect of the expiration of one of its blockbuster anti-platetet drugs, Plavix, in 2012. The second setback came from proposed budgetary cuts for Medicaid and Medicare. Yet the stock is trading near its five-year high. We believe it is a buy, for three reasons:
· Strong financials. Hefty operating margins, above its peers Pfizer, Abbott Laboratories, Eli Lily and Merck.
· A strong pipeline of new products, some of which have already gained FDA approval.
· A string of acquisitions that help the company rebuild its pipeline. Last Saturday, the company paid $5.3 billion for Amylin Pharmaceuticals (AMLN), the maker of two diabetes drugs, while last February, it acquired Inhibitex.
Investors should be warned, however, that Big Pharma is facing a number of headwinds that may derail the recent rally. First, a strong product pipeline doesn't guarantee that these products will get FDA approval. Second, a shortfall from the fiscal cliff, the prospect that the US government cut expenditures across all categories, including healthcare. Third, the oligopolistic nature of the healthcare industry, which has the power to dictate drug prices, and even drop coverage, as was the case with Questcor Pharmaceuticals (QCOR).
The bottom line: Most of the bad news is behind for big pharma stocks. And with the Fed deciding to keep interest rates at record low levels, they offer an attractive alternative to money markets and CDs. Hype, however, souldn't be a substitute for due diligence, especially with the looming fiscal cliff.