Drug giants get the upper hand -- for now
While the top pharmaceutical companies are up slightly this year, biotechs are struggling a bit. But that may not last long.
NEW YORK (CNNMoney.com) - Remember way back in 2005, when Big Pharma was the whipping boy, but biotech stocks were so hot they could do no wrong?
Well, the tables have turned in 2006. Sort of.
Major drug makers' stocks have gained only slightly so far this year, up 0.6 percent, although they've underperformed the 3.3 percent advance of the S&P 500. Meanwhile, biotech shares have dropped 4.6 percent during the same period.
Compare that to last year, when Big Pharma stocks were trounced by the gains made by biotechs. While the drug giants dropped 4.3 percent, biotechs surged 20.7 percent. At the same time, the S&P 500 gained 4.7 percent.
"What people are seeing in the biotechs is a decelerating growth rate," said Les Funtleyder, analyst for Miller Tabak. "Biotech valuations have grown to the point where it's going to take awhile for them to grow into the valuations."
Funtleyder said the big drugmakers are restructuring and are "not really in a growth mode." But they have managed to attract investors this year because "they pay dividends and the (price/earnings) multiples are really cheap."
Analysts said biotech stocks are overvalued and likely to keep sliding, though it was unclear how long the major pharmaceutical companies will continue to advance because pipelines for future drugs still fail to impress.
"A valuation gap emerged between the sectors that did not appear to be sustainable and what we're seeing now is a correction of that gap," said Geoff Porges, analyst for Sanford Bernstein. "We're back to a more consistent and sustainable relationship between the sectors."
Pfizer vs. Amgen, Merck vs. Genentech
A look at the industry leaders demonstrates the disparity between the big drugmakers and biotech stocks.
Drug giants such as Merck and Pfizer are up a little this year, leaving behind the declines and flat values of 2005. Shares of Merck (down $0.29 to $33.65, Research), the second-biggest American drug company, has risen 6.7 percent year to date, compared to a mere 1.9 percent advance for all of 2005. Pfizer (down $0.04 to $24.46, Research), the world's biggest drug maker, is up 5.1 percent year to date, compared to last year's drop of 11.6 percent.
Meanwhile, bellwether biotechs have reversed course from last year's heady gains. Shares of Amgen (down $0.60 to $69.47, Research), the biggest biotech, is down 11.1 percent, after its stock price climbed 25.3 percent in 2005. Genentech (down $0.34 to $81.34, Research) stock has fallen 11.7 percent year to date, after its stock surged 72.7 percent last year.
"Those [biotech] big caps really had their run in 2005 and aren't expected to do a lot in 2006," said Andrew McDonald, analyst for ThinkEquity Partners.
But looking ahead over the next several years, McDonald said there's a good chance that Big Pharma and biotech stocks could return to the stark disparities of 2005 as biotechs continue to grow but traditional pharmaceutical companies fail to impress with weak pipelines. Also, the larger companies face increasing pressure from generic competition as $100 billion worth of branded drug revenue loses patent protection over five years.
"Big Pharma has really been beaten down in the last several years, driven by the number of patent expirations and generic entries, which is only expected to get worse," said McDonald. "So I think it would be premature to call it a Big Pharma rally at this point."
To find out why biotechs did so well in 2005, click here.