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Drug sector in decline?
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December 14, 2001: 5:53 p.m. ET
With two major warnings, safe-haven drug stocks look a bit cyclical.
By Kim Khan
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NEW YORK (CNN/Money) - The pharmaceutical sector is supposed to be a bunker where investors hole up and see steady earnings growth in tough times. But with two major companies sharply reducing earnings forecasts for next year,
cracks are beginning to form in the shelter.
On Tuesday Merck & Co. (MRK: up $0.15 to $58.09, Research, Estimates) shocked investors and analysts, saying they expect no earnings growth for 2002 and calling the next four quarters a "transition year."
Two days later Bristol-Myers Squibb (BMY: up $1.00 to $50.00, Research, Estimates) followed suit, saying earnings for 2002 would be lower than 2001 and dubbing 2002 a "bridge year."
Tim Anderson, drug analyst with Prudential Securities, said it is surprising to see drug stocks acting like cyclicals, but sees a recovery by the middle of next year.
"You've had nothing but bad news on the group," Anderson said. "It's a reason why the stocks are cheap generally."
"But there are lots of drugs coming to market and 2003 looks like the start of an upturn," he added.
Banc of America Securities analyst Len Yaffe said the growth rate of the pharmaceutical sector as a whole is slowing down from the fast rate it saw from 1996 to 1999, but said he felt the warnings were specific to the companies rather than the industry.
"There's isolated incidents of companies (warning) because of patent expiration or pipeline problems or both, but they are very isolated," Yaffe said.
Merck's sales will be hurt by the patent expiration of heartburn and ulcer drug Prilosec and Bristol-Myers sees an 80 percent decline in sales of its diabetes drug Glucophage.
"I really think what you've had here is that they've all had the same issue, losing product patents," said Jeff Chaffkin, analyst with UBS Warburg. "It's hard to simply offset that with cost cutting, but it's nothing systemic in the company."
Chaffkin said Bristol-Myers' struggle also shows it's getting harder and harder to get people to switch to a newer version of an established drug, which the company tried to do with Glucophage.
That could be a problem for Schering-Plough (SGP: up $0.65 to $38.00, Research, Estimates), which is expected to try and get patients to switch to a newer version of its allergy drug Claritin before the patent expires at the end of 2002.
No need to avoid the sector
From an investor standpoint, market strategists are confident nothing fundamental has changed in the pharmaceutical sector, which will continue to see earnings growth.
Tony Dwyer, chief market strategist with Kirlin Securities, said it was coincidental to see two big companies warnings because of similar problems.
"The stocks are acting like they're economically sensitive, but it's just two companies warning on their pipeline," Dwyer said.
Alan Ackerman, stock market strategist at Fahnestock & Co., said he sees a period of "creative consolidation" with companies facing patent expiration looking to the biotech sector for possible acquisitions.
Along with biotech firms, Ackerman said pharmaceutical stock could be attractive.
"My current suggestion is to let the dust settle and look for buying opportunities," Ackerman said. "One of my favorites is Pfizer."
Eli Lilly (LLY: up $1.34 to $81.81, Research, Estimates) was also mentioned as a strong stock, having successfully weathered the loss of exclusivity on depression treatment Prozac.
"Lilly to us is going to emerge as the drug company of the decade," Lehman's Yaffe said. 
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