Scottish Equitable Asset Management has reduced the size of its underweight position in pharmaceutic...
Scottish Equitable Asset Management has reduced the size of its underweight position in pharmaceuticals in the belief that valuations are reaching attractive levels.
The sector has underperformed the US market over the last year with the S&P Drugs index seeing a fall of 32.94% in dollar terms in the 12 months to 14 March compared with a rise of 5.32% in the S&P 500 over the same time period.
Paul Kleiser, US fund manager at Scottish Equitable Asset Management, says that the group has moved to a slightly underweight from a significantly underweight position in the sector since the beginning of the year. Merck is currently trading on a P/E of 24.31 times compared with its peak P/E of 40.07 times a year ago. Bristol-Myers Squibb is on a P/E of 25.42 times compared with its peak of 38.96 times last September. Kleiser has been quietly increasing weightings in both.
He says: "Their growth prospects are a little slower than they were, at 12% to 13% on average, compared with 16% or 17% a year ago. A growth rate in the low teens is not to be sneezed at, particularly if it can be achieved year in, year out. There is also the issue of relative growth. One would expect the growth rate for the market as a whole to slow down while we believe the growth rate for pharmaceuticals companies will rise or stay the same."
Terry Ewing, head of US equities at Britannic Asset Management says that the group has been underweight pharmaceuticals for the past 10 to 12 months and Britannic is currently around half weighted in the sector.
Ewing says that the sector has been underperforming recently as the market began to recognise that the flow of blockbuster drugs such as Viagra during the 1990s was unsustainable and this has been harming growth rates. For example, Merck admitted earlier this month that it would find it difficult to achieve strong growth without getting involved in merger and acquisition activity.
Ewing says: "The pharmaceuticals sector also does not like high interest rates. This is not because the sector is heavily indebted and these stocks are not cyclical. The sector is seen as a long-term asset and we think that until we see an end to the move upwards in interest rates, that is the point when we can see that the next rise is going to be the last, the sector is going to remain under pressure."
Ewing adds that there is likely to be renewed political pressure on the sector, with much talk of reform of the US healthcare sector which will involve pushing down the price the Federal government pays for drugs.
He thinks that concrete legislation to tackle this is unlikely in the short term and does not believe that this factor is a big negative for the sector.
Britannic estimates that the worst case scenario is that pricing pressure in the drugs market will take 1% to 2% off the growth rate of pharmaceuticals companies.
Among the pharmaceuticals he holds are Pharmacia & Upjohn which he sees as benefiting from cost savings from its takeover of biotechnology firm Monsanto. Pharmacia & Upjohn saw its share price fall by 6.47% in the 12 months to 14 March. He also holds Pfizer which is taking over pharmaceuticals firm Warner-Lambert.
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