Large pharmaceutical companies all seem to be in a similar boat heading into 2009. Most of the names in the industry are facing significant patent challenges in the years to come. U.S.-based firms are facing foreign exchange headwinds as well. Revenue growth is non-existent, and earnings growth is being driven primarily by cost-cutting and share buybacks.
Knowing that investors rarely pay-up for this type of manufactured earnings growth, we struggle to see a broad-based out-performance for the large-cap pharmaceutical sector in 2009.
Valuations, however, are attractive, with several of the largest players trading at PEs below 10x, including Pfizer (PFE, 7x), Eli Lilly (LLY, 9x), Merck (MRK, 9x), Sanofi (SNY, 9x), and Schering-Plough (SGP, 10x) based on our fiscal 2009 estimates. Attractive valuations, along with big dividend yields, should protect investors against significant downside risk even if the economy continues to languish well into the second half of the year.
Additionally, expectations are low. Knowing that most of the companies are not expected to generate significant revenue growth, and that cost-cutting initiatives have generally out-paced guidance and financial modeling, any bit of revenue upside could lead to select out-performance at times during the year.
M&A activity remains the wildcard for investment in the sector. We have already seen a significant number of deals so far in 2009, with Pfizer's $62 billion acquisition of Wyeth (WYE) leading the way. Roche's $42 billion offer to Genentech (DNA) is not too far behind, showing that big pharmaceutical names are keenly aware of their patients' situations and turning to biotech for answers.
Most of the industry's largest players are sitting on significant cash balances, and if Pfizer's five-bank model for short-term funding holds, additional capital is available for the top players. This should allow for a significant deal activity later in the year.
Buy-rated names, including Bristol-Myers (BMY) and Johnson & Johnson (jnj), are sitting on $10 billion and $16 billion, respectively. Given the difficult cash-raising environment during the second half of 2008, most small to mid-sized biotech firms are eager to partner with pharmaceutical companies in 2009.
