Are Pharmaceuticals A Good Place To Hide Out In A Down Market?

Names that were previously viewed as safe and stable investments, large-cap pharmaceuticals, are now trading at levels not seen since 2002.  And, for some such as Pfizer, Inc. (PFE) and Eli Lilly & Co. (LLY), these are prices not seen since the past decade.

This is clearly a sell-first, ask questions later market. After all, believing that patients are going to stop taking Bristol-Myers Squibb Co. (BMY) blood-thinner Plavix or Pfizer’s anti-cholesterol agent Lipitor because of the credit crunch is the epitome of irrational anxiety.

Pharmaceutical stocks are historically excellent places to put money in troubled times.  Although not completely recession-proof, there are several key underlying characteristics that make the industry a good place to hide out in a down market.

OPPORTUNITIES

Big cash balances and big dividends are two key things investors should look for in large pharma.  Money is tight, and with stock prices seemingly caught in a relentless decline, pharma investors can sleep well knowing that the companies they own are well capitalized and still paying shareholders an attractive return.

Take, for example, Pfizer, the industry’s largest player.  As of the end of the third quarter 2008, Pfizer held $27 billion in cash and equivalents.  The market is crumbling, and meanwhile Pfizer is sitting on enough cash to buy Biogen Idec, Inc. (BIIB), Amylin Pharmaceuticals, Inc. (AMLN), Forest Laboratories, Inc. (FRX), Sepracor, Inc. (SEPR), Dendreon Corporation (DNDN), Arena Pharmaceuticals, Inc. (ARNA), Onyx Pharmaceuticals, Inc. (ONXX), OSI Pharmaceuticals, Inc. (OSIP) and Elan Corporation Plc (ELN) — all without issuing one share.  And, while we wait for Pfizer to put its enormous cash balance to work, the dividend yield is nearly 8%.

We have a Buy rating on Abbott Laboratories (ABT) ($7B in cash, 3% yield), Johnson & Johnson (JNJ) ($15B in cash, 3% yield), and Bristol-Myers Squibb (BMY) ($8B in cash, 7% yield).  All 3 of these companies are well capitalized and well positioned for future growth.

This year we have already seen some sizable deals with Takeda acquiring Millennium, Roche bidding for Genentech, Inc. (DNA) and Lilly’s recent surprise move to acquire ImClone Systems Inc. (IMCL).

Cash is king in big pharma. The shopping spree will continue. Start investing in the industry’s strongest and best positioned names to take advantage.

In the large-cap biotechnology market, we remain bullish on Genentech and Biogen Idec.  Both core businesses remain solid, and both companies have an enormous biologic pipeline and manufacturing footprint.  These are two key assets that should allow both Genentech and Biogen to outperform when normalcy returns to the market.

WEAKNESSES

Avoid names that are in the opposite position.  Stay away from anyone trading on the hopes and prayers of a phase III trial outcome or the decision of the FDA.  Now is not the time to be taking on risk.  This year has been one of the slowest on record for approvals, and it seems like just about every FDA action (PDUFA) date has been pushed back.

Stay away from companies that are all ideas and no assets.  Above we discussed four key measures to hang your hat on:  cash, dividends, pipelines and strategic assets like biologic manufacturing.  If your target company has none of these, now is probably not the best time to roll the dice.

Run from any company looking for money or looking to raise money in the next year. Interest rates on direct financing loans are going to be through the roof, and stock prices are down so big that share offerings will be painfully dilutive.

Finally, do not try to predict which are the companies that are going to be taken out.  There are far too many and big pharma rarely comes in to rescue of stocks below $5.  We do not recommend trying to catch falling knives such as Amylin, Forest Labs, Arena, Sepracor, or United Therapeutics Corporation (UTHR). Rather, wait for the recovery and buy any one of the above down-and-out names when confidence returns.  Until then, now is not the time to try to be a hero.

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