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Stock Strategist Industry Reports

Improved Outlook for Big Pharma Stocks in 2009

While challenges remain, we expect Big Pharma to perform well in 2009.

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Following an approximate 25% haircut in their share prices in 2008, we expect pharmaceutical stocks to perform well in 2009. Relatively few major patents expire in 2009, and we believe the industry's major patent expirations beginning in 2011 have largely been factored into drug stocks' valuations. Also, we project several new drugs will gain traction in 2009, as well as a few key blockbuster approvals. Additionally, we expect a large amount of data flow, setting up strong pipelines for patent-weary pharmaceutical companies to take into the patent cliff in 2011. Further, we believe continued cost cutting will buoy earnings growth and acquisitions will augment internal growth.

On the negative side, we expect the new U.S. government will begin to draft unfriendly industry legislation in 2009, creating head winds for the group. Also, while notoriously difficult to predict, foreign exchange rates could work against U.S. drug companies. Additionally, while the recessionary environment will likely weigh down growth, we believe drug sales will show a large degree of resistance to a deteriorating economy.

Less Patent Head Winds in 2009
On the heels of numerous 2008 blockbuster patent expirations--highlights include  Johnson & Johnson's (JNJ) antipsychotic Risperdal,  Merck's (MRK) osteoporosis drug Fosamax,  GlaxoSmithKline's (GSK) epilepsy treatment Lamictal,  Pfizer's (PFE) cancer drug Camptosar and allergy drug Zyrtec,  Abbott's (ABT) epilepsy drug Depakote, and  Wyeth's (WYE) heartburn drug Protonix--we expect relatively minor patent losses in 2009. While on an annual basis, some of the midyear 2008 patent losses will spill into 2009, we expect only a couple of major patent losses in 2009, including Johnson & Johnson's epilepsy drug Topamax and GlaxoSmithKline's antiviral treatment Valtrex. Without significant patent head winds, we expect less-volatile sales growth in 2009.

Recently Approved Drugs Gaining Traction
We expect several recently approved drugs will add to the top line in the upcoming year. Specifically, we project Abbott's cardiovascular drug Trilipix and GlaxoSmithKline's bleeding treatment Promacta will begin to ramp toward blockbuster status. Also, we expect Pfizer's overactive bladder drug Toviaz will help augment the company's urology franchise. All of these drugs were approved in the fourth quarter of 2008, setting the stage for growth in 2009. Further, we expect  Novartis(NVS) hypertension drug Tekturna will post strong gains in 2009, following Novartis' 2008 buyout of Speedel's rights to the drug.

Critical New Approvals
We expect key approvals in 2009 will support long-term growth in the industry. In particular, we project a greater than 70% chance of approval for  Lilly's (LLY) cardiology drug Effient,  Schering-Plough's (SGP) and Johnson & Johnson's rheumatoid arthritis drug golimumab, and  Bristol-Myers(BMY) and  AstraZeneca's (AZN) diabetes drug Onglyza. All of these drugs should reach well over $1 billion in peak sales. Also, regulatory agencies could approve Schering's antipsychotic drug Saphris, but the drug's checkered past diminishes our expectations for it.

Important Data Flow
We expect robust data flow in 2009, as well as many new drug filings. We expect positive data from Novartis' FREEDOMS trial in mid-2009, which will set up the filling for its multiple sclerosis drug FTY 720. In late 2009, we expect two new filings from Merck, for acute heart failure drug rolofyline and migraine drug telcagepant. Also, toward the end of 2009, Schering could release the SHARP data, which we expect will reinforce the efficacy and safety of cholesterol drug Vytorin. Additionally, while a long shot, an advisory committee on  Sanofi's (SNY) cardiology drug Multaq could recommend the drug, creating a major opportunity for the company. Also, we expect a barrage of oncology data from all big pharma companies, since the group has moved more aggressively into the space.

Continued Cost Cutting and Increased Acquisitions
We expect continued cost cuts and more acquisitions as companies adapt to past and upcoming patent losses. We believe the greater focus on cost cutting slightly increases the odds of a major pharmaceutical merger. However, we feel smaller acquisitions are much more likely. Given the poor equity and credit markets, we feel many of the cash-strapped small biotech companies have increased their willingness to be acquired at much lower valuations. Like kids in a candy store, we believe cash-rich large pharmaceutical companies will increase their acquisitions and partnerships. Further, while the Roche (RHHBY) and  Genentech (DNA) merger will likely represent the largest consolidation in 2009, we expect Pfizer will make a major move over the next year. Pfizer holds approximately $25 billion in cash and needs to prepare for the 2011 patent loss on cholesterol drug Lipitor.

Long-Term Government Head Winds Begin
We believe the new administration and Congress will push forward several legislative initiatives that could negatively impact the drug industry. We believe issues will include universal health insurance coverage, a pathway to approval of generic biologics, and increased government negotiating power for Medicare Part D. With their primary focus on the recession, Congress will likely need at least a couple of years to pass meaningful changes, and we therefore expect few of these programs will significantly impact 2009 sales and earnings. However, drug stocks could face increased headline risk over the next year. While we think the risk of greater government pricing power under a universal health-care system remains a chief concern among investors, we expect a role for private insurers in the eventual passage of any type of universal health-care coverage, slightly diminishing the risk of strict government drug pricing controls. Additionally, universal coverage should greatly increase drug utilization, leading to larger drug volume sales and partly mitigating loss of drug pricing power.

Foreign Exchange Challenges
Following several quarters of foreign currency gains, we believe the stronger dollar will begin to work against the large U.S. pharmaceutical companies. We expect a low- to mid-single-digit reduction to sales growth. Schering and Pfizer will likely feel the worst of the foreign exchange rate head wind, as we expect them to generate 70% and 57% of total 2009 sales, respectively, from international markets. Conversely, Merck should feel the least impact, with 45% of 2009 sales expected from overseas.

Pharmaceutical Sales Resistant in Rough Economy
While the slowing economy will likely create a drag on growth, we expect the pharmaceutical industry to hold up reasonably well. As consumers cut back on spending, we believe drug expenditures will remain relatively unscathed. The higher relative importance of health care should push consumers to reduce spending on more elective goods rather than prescriptions. Further, the majority of consumers use insurance to purchase their drugs, mitigating the burden of drug expenses. We don't expect much change in international government-funded drug programs, which make up the majority of overseas sales. These many layers of insulation should provide pharmaceutical companies shelter from the slowing economy. Even with the challenging foreign exchange environment and the likely negative U.S. government actions, we believe that the improving underlying fundamentals of pharmaceutical stocks will lead to stock price appreciation in 2009.

Damien Conover does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.