(The author is a Reuters contributor. The opinions expressed
are his own.)
By Conrad de Aenlle
June 10, Drugmakers have become fond of one
The value of mergers in the industry was 20.9 percent higher
in the first quarter than the fourth, reaching $44.9 billion,
according to a PricewaterhouseCoopers report that predicts
continued robust activity.
The wheeling and dealing has helped lure investors, judging
by the double-digit percentage gains this year in many drug
stocks, but it has stirred caution in fund managers with heavy
exposure to the industry. With high stock prices and some
takeover bids viewed as less prudent than others, don't get
sidetracked by the prospect of further mergers, money managers
say. Instead, they continue to focus on the basics: valuations,
growth prospects and income.
A takeover bid that caused much consternation didn't even go
through after AstraZeneca PLC said "no thanks" to Pfizer
Inc. in April. The episode caused Eric Sappenfield,
co-manager of the John Hancock Global Shareholder Yield Fund
, to turn cautious on Pfizer, although he still owns
"The bid for AstraZeneca was a 180-degree turn," says
Sappenfield, whose fund is a top performer over three and five
years among world equity funds, according to Lipper, a unit of
Thomson Reuters. "You have to trust management. The jury is out
on what management is trying to do at Pfizer. The bid caught
people by surprise."
Pfizer is the largest holding in T. Rowe Price Institutional
Global Value Equity Fund, which ranks in the top
quintile in returns over the last year among world equity funds,
according to Lipper.
"They're very well managed, they're great at generating cash
from their existing franchise, and they're skilled at deals,"
despite the failed attempt to woo AstraZeneca, says the fund's
manager Sebastien Mallet. He likes Pfizer's valuation of 13
times estimated 2014 earnings and 3.5 percent dividend yield.
Three of the other top 10 holdings in the T. Rowe Price fund
are large drugmakers, too. Overall, healthcare represents 16
percent of the portfolio. (The fund has a total expense ratio of
"After strong growth in the 1990s, the drug industry "became
complacent, with unfocused (research & development) and very
little to show in their pipelines," Mallet recalls. "The stocks
were cheap and controversial, so I bought a lot of them." In
recent years, he contends, drug companies have become more
efficient businesses, and their research efforts are improving.
One of his holdings, Novartis AG of Switzerland,
swapped some of its assets in April for others belonging to
GlaxoSmithKline PLC. Mallet expects the move, sort of a
merger-lite, to allow the companies to play to their strengths -
cancer treatments in Novartis's case.
A big draw of another holding, Teva Pharmaceutical
Industries Ltd., is its cheap valuation of 11 times
estimated 2014 earnings. Concerns about the imminent expiration
of patents on its leading drug, Copaxone, a multiple sclerosis
treatment, are "overblown" because the Israeli company is
developing easier, less expensive, less painful methods of
administering Copaxone that he expects to limit the appeal of
Mallet describes another portfolio constituent, Johnson &
Johnson, as "a sleepy company with fantastic assets that
became more focused and started to have a better pipeline on the
pharma side." At about 16 times estimated 2014 earnings, its
valuation is in line with the broad market, but "it's a very
high-quality company, solid as a rock," he says.
Sappenfield is less interested in value than growth, which
he considers vital to a company's ability to pay and increase
its dividend. He has a modest stake in Johnson & Johnson, which
he admires for having "an abnormally high growth rate for the
kind of battleship company they are."
Sappenfield prefers other drug stocks, though, including
Novartis, Glaxo and two others in Europe, Sanofi SA of
France and its Swiss counterpart Roche Holding AG. He
favors them not just for their ability to grow but to do it
"Pharma companies generate a reasonably predictable stream
of profits," Sappenfield says. "You want to see that
consistency. That's why we're in the big guys. They're marketing
machines with sustainable pipelines."
His fund has about a 9 percent stake in healthcare stocks -
less than average - but he rates drug stocks highly while
shunning other segments of the healthcare group, such as medical
equipment providers and hospital operators. The John Hancock
fund has a total expense ratio of 1.34 percent, according to
Sappenfield isn't too worried about paying the right price
for stocks, but he hates to pay the wrong price. He sold
Bristol-Myers Squibb Co because it got too expensive, he
says. "Expectations for some of their drugs were so outrageous
that everything had to be perfect for Bristol-Myers to work."
Mallet expresses some valuation concerns of his own.
Although his exposure to drugmakers remains high, it has come
down slightly as price-earnings multiples have increased, and he
expects to cut back further if the trend continues. But he still
finds far more working for them than against them.
"They have refocused their business models and cut costs,"
he says. "The stocks are less cheap, but they still have good
cash-flow generation and dividend payments."
(Follow us @ReutersMoney or here;
Editing by Lauren Young and Nick Zieminski)