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Diagnosing drug stocks
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June 30, 2000: 3:31 p.m. ET
Despite gains, Wall Street still uneasy about outlook for pharmaceutical sector
By Staff Writer Martha Slud
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NEW YORK (CNNfn) - After months of playing the role of wallflower at the school dance, pharmaceutical stocks are looking a little bit sexy again.
Wall Street went wild Thursday over news that Eli Lilly and Co. (LLY: Research, Estimates) achieved promising clinical trial results for an experimental drug to fight sepsis -- a deadly bacterial disease with no existing pharmaceutical treatment.
The news surprised many analysts, who hadn't even factored in potential sales of the drug, Zovant, in their profit models for the company. Investors sent the stock soaring 17 percent in one day.
Other drug makers, including Pfizer Inc. (PFE: Research, Estimates) and Schering-Plough (SGP: Research, Estimates), also are sitting on recent gains, although none has seen as big a one-day jump in recent memory as Eli Lilly enjoyed. Overall, the American Stock Exchange Pharmaceutical Index is up more than 18 percent since April 1, compared with a 3 percent slide in the S&P 500 index during the same period.
Industry analysts say investors are anticipating solid earnings from pharmaceutical companies in the second quarter, which ends Friday.
Investors also are looking ahead to strong long-term growth prospects from two new industry behemoths - Pfizer Inc. (PFE: Research, Estimates), which just closed its acquisition of Warner-Lambert Co., and Pharmacia Corp. (PHA: Research, Estimates), the company created by the merger of Pharmacia & Upjohn and Monsanto Co. earlier this year.
 But for the most part, analysts say, the drug sector is benefiting not from any dramatic improvement in the industry's fundamentals, but from overall market fears that the U.S. economy is slowing.
The cooling of the economy -- and the concern that the Federal Reserve may not be done raising interest rates - is encouraging investors to seek out some safe havens, such as pharmaceuticals, food and energy, which are generally considered less sensitive to rate hikes, analysts say.
"The more that the 'recession' word has been used and a slowing economy ... people are going to run to safe havens," said Neil Sweig, a pharmaceutical analyst at Ryan Beck and Co. "It's an external event that has powered drug stocks to have an excellent second quarter."
 In fact, analysts say, the drug industry has some major clouds hanging over it.
Among the biggest worries is the prospect of a prescription drug benefit added to the federal Medicare program, a Clinton administration proposal that the pharmaceutical industry opposes in its current form.
Drug companies argue that the Clinton plan, which would help subsidize prescription drug coverage for millions of elderly Americans through a broad new government benefit, would lead to price controls on their industry that would consequently slash profits and reduce spending on research and development.
The industry does, however, support Republican proposals in Congress that would add drug benefits under Medicare through mostly private sector initiatives.
 Analysts say the Medicare issue is not likely to be resolved until well after the November presidential election - creating a lot of uncertainty around pharmaceutical stocks.
"That's a very big negative overhang on the drug sector," said Hemant Shah, an independent pharmaceutical analyst.
Looking for blockbusters
Meanwhile - Eli Lilly's announcement aside -- the industry does not have too many prospects for major blockbuster drugs, analysts said. A "blockbuster" in the drug industry is considered a product that hits peak sales of at least $1 billion annually. 
Slower prospects for pharmaceutical breakthroughs were one reason that many investors shifted money into highflying biotechnology stocks earlier this year.
The sequencing of the human genome - which researchers earlier this week announced they had virtually completed - has created a stir around upstart biotech companies that have promised to revolutionize medicine through genomics research. However, many of those volatile biotech stocks have fallen sharply from their highs, and analysts warn that new drugs stemming from genomics discoveries likely are years away.
Analysts say the big pharmaceutical companies are working on some promising new treatments - including AstraZeneca PLC's (AZN: Research, Estimates) experimental cholesterol medication, ZD4522, a drug that could rival Pfizer's lucrative drug Lipitor; and Pfizer's proposed Zeldox, an anti-psychotic medication currently up for U.S. Food and Drug Administration approval.
 But, analysts said, there's little in the short-term pipelines that is likely to generate as much excitement as Viagra, Pfizer's blockbuster impotence remedy, or Lipitor, when those products were introduced a couple years ago.
If, however, drug companies can come through with some innovative new treatments for cancer and diabetes, "those are the two areas where the markets are so unsatisfied," Shah said.
"If someone can come up with a big positive surprise there, it would be very good news," he said.
Meanwhile, analysts say the recent gains in pharmaceutical stocks have made some of them pretty pricey.
Many Eli Lilly investors apparently think so too, triggering a roughly 3 percent sell-off in the stock Friday after Thursday's surge. Analysts point out that even though the company's announcement about clinical advances for its sepsis drug is good news, the earliest the product could go on the market would be late next year. That means the drug - which still requires FDA approval -- would not begin to contribute to the bottom line until early 2002.
Sweig, of Ryan Beck, recommends that investors with heavy pharmaceutical holdings may want to lighten up a bit and take some profits.
"Some of the stocks have grown expensive, and there is less and less room for any disappointments in these drug stocks," he said. "That is cause to think." 
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