Drug Stocks That Are Under the Radar

Includes: JNJ, MRK, NVS, PFE, ROG, SNY
by: Larry MacDonald

Many companies have sound balance sheets, excellent business models and great growth potential. But if they don’t have an ability to produce fees for the brokerage industry, they are often overlooked by “sell-side” investment analysts.

True, there are some exceptions within the “sell-side” analyst community. Independent outfits, like Standard & Poor’s equity researchers, concentrate on pure research and don’t have underwriting or trading departments to placate. Issuer-paid research boutiques are another exception. But they remain in the minority.

Most small caps fit the description of stocks flying under the radar. But so do many large caps headquartered outside of the United States. Wall Street seems to have little interest in them even though many might have better fundamentals than their U.S. peers.

A case in point is big-cap European pharmaceutical companies, according to an article in the June 5 issue of Investor’s Digest of Canada. Author Randy McDuff notes that U.S. companies have a ton of analyst coverage while the European ones do not.

Take the big three in the U. S. Johnson and Johnson (NYSE:JNJ) has 17 analysts, Merck (NYSE:MRK) has 15 and Pfizer (NYSE:PFE) has 13. The three big European firms (all in top 7 of the global industry) have little: Roche (NYSE:ROG) has 1, Sanofi-Aventis (NYSE:SNY) has 4, and Novartis (NYSE:NVS) has 4.

Moreover, there seems to be a bias on Wall Street, says McDuff. U.S. drug companies are doing poorly and forecasting revenue and profit declines, yet no analysts have a “sell” recommendation on the big three. Meanwhile, European firms are living up to the recession-proof reputation of their industry and reporting record financial results and raising dividends, yet remain rated less favorably. For example, McDuff’s top pick, Paris-based Sanofi-Aventis, has two “sell,” one “hold,” and one “buy” from Wall Street.

Sanofi-Aventis stats:

• 3rd largest drug company in world by revenue
• Strongest balance sheet of the top 7 firms
• Projected 7% growth rate in 2009 revenues (tops among big 7)
• Leader in vaccine market; 2nd in diabetes market
• Dividend yield over 4.5%
• Payout ratio at 34% (83% dividend growth since 2003)
• EV/EBITDA of 7 vs. industry ratio at 9.