The pharmaceutical industry is entering a period of substantial change in 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 mergers, 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, 7.5x),
Eli Lilly (
LLY, 8.1x),
Merck (
MRK, 8.3x),
Sanofi (
SNY, 7.5x),
AstraZeneca (
AZN, 7.6x) and
GlaxoSmithKline (
GSK, 9.3x) 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 three significant mega-deals so far in 2009, with Pfizer's $62 billion acquisition of
Wyeth (
WYE) leading the way.? Roche's $46 billion takeover of Genentech and Merck's (MRK) $42 acquisition of
Schering-Plough (
SGP) prove that companies are desperately seeking for ways to grow the top-line while cutting-costs all at the same time.
Big pharmaceutical names are keenly aware of their patient situations, and ARE turning to deal-making for the answer. Most of the industry's largest players are sitting on significant cash balances, and Pfizer, Merck and Roche all proved that capital is available for the top players. We expect more deals to come.
Buy-rated names, including
Bristol-Myers (
BMY) and
Johnson & Johnson (
JNJ), are sitting on $9 billion and $14 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.
According to a recent analysis by the Wall Street Transcript, 25% to 35% of all publically traded biotech firms are sitting on less than six months' cash. That has created a frenzy within the sector to form alliances and strike deals. The recent emphasis has been on cancer biotech firms heading up to and now post the
American Society of Clinical Oncology (ASCO) meeting. J&J just recently announced its intentions to acquire
Cougar Biotech (
CGRB) for approximately $1.0 billion in cash.
Asset prices for early-to-mid stage product candidates are very cheap, and pharmaceutical companies are now willing to look at phase I and phase II candidates in 2009 -- something most managements have been hesitant to do in the past.
