US pharmaceuticals recently posted stronger than expected second quarter figures but are at the high...
US pharmaceuticals recently posted stronger than expected second quarter figures but are at the high end of their valuations, trading on an average P/E multiple of more than 30.
Phil Chappell, US fund manager at Perpetual, is positive on the sector and says pharmaceutical companies like Merck and Pfizer have benefited for a variety of reasons.
Speculation on the patents held by Merck coming to an end has driven the price lower. US patents tend to last 10 years, during which time the company can charge monopoly prices for its product in return for it investing heavily into research and development.
Chappell has a fairly big holding in the firm because of its relatively low price and anticipated new products. Merck, which produces the non-steroid asthma drug Singulair, produced second quarter profits which were much better than expected, beating estimates by 3% to post earnings of $9.48bn, up 18% on last year.
Chappell says he has a decent holding in Pfizer, the world's largest pharmaceutical, which recently announced an earnings rise of 21% to $1.44bn. This excluded the company's purchase of Warner-Lambert, a consolidation Chappell feels will assist the company's productivity.
Heather Kang, portfolio manager for Prudential's PPM America fund, says there has been a lot of consolidation in the sector as a result of falling earnings. Some pharmaceuticals have posted strong second quarter earnings but warned they do not expect earnings growth to rise as strongly for the rest of the year.
Kang says one reason for this is that pipeline prospects are not as strong as expected and pharmaceuticals need to expand to smooth their roll-out of new products, which often falter during the testing process.
Under Federal Drug Administration rules, new treatments must go through three phases before they become available for public consumption, according to Chappell.
He says: "People often get excited when a company announces it is testing a new product but often these fail at stage two or three and never make it to the market."
Chappell believes drug companies, with their steady, mid-teens profits, will become more appealing to investors looking for a safe berth while the US economy slows down.
Kang says she is heavily underweight the sector as she feels valuations are expensive.
She adds: "I think the valuations have a lot to do with what is perceived as a growth stock. Most of the big pharmaceuticals are trading on a P/E multiples of 30-40 times, yet people are looking to them for safety as the US economy slows."
One factor that could affect pharmaceuticals is the US government's attempts to reduce the prices of medicines and treatments to Medicare levels, which would involve some form of price capping.
Chappell and Kang both feel that political interference would negatively affect the prices of pharmaceuticals.
Kang says: "Senior citizens are the heaviest users of pharmaceuticals. If they get prescription coverage, they will be able to negotiate price levels to some extent."
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