Poor pharma performance shows no sign of let-up

NEW YORK/LONDON (Reuters) - Investors can expect more gloom from pharmaceutical companies this week after initial lackluster earnings from some of the largest in the industry underscored a range of ills.

The results further soured investors on drug makers' shares, which had already fallen across the board over the past year. The declines have largely stemmed from concerns over growing generic competition, major research problems for particular drugs, and fears of a tougher U.S. regulatory and political climate.

All this has underlined how much "big pharma" has lost its traditional image as a defensive investment play during rocky economic times.

"It's the start of what looks like a pretty bloody pharma results season," said Nomura Code Securities analyst Paul Diggle.

The American Stock Exchange Pharmaceutical index .DRG, which consists mainly of large U.S. and European drug makers, has fallen some 12 percent this year, underperforming broader indexes.

Some companies -- such as Pfizer (PFE.N) and Eli Lilly (LLY.N) -- are wrestling with or preparing for generic competition to their top products. GlaxoSmithKline (GSK.L) and Amgen (AMGN.O) are among those contending with safety worries over their big sellers. AstraZeneca (AZN.L) and Wyeth WYE.N exemplify companies hit by major research disappointments.

"It's a combination of company-specific and macro issues that have been impacting the sector for a number of years," said Ruairi O'Neill, senior equity research analyst with PNC Capital Advisors.

Investors dumped pharmaceutical shares last week after disappointing sales or outlooks from Pfizer, the world's largest drug maker, as well as Roche (ROG.VX) and Forest Laboratories (FRX.N). A weak dollar boosted Johnson & Johnson's (JNJ.N) otherwise anemic sales, while Abbott Laboratories' (ABT.N) solid results failed to excite the market.

THE WEEK AHEAD

Most of the other large drug companies will report this week, starting with Merck & Co (MRK.N), Novartis (NOVN.VX) and Eli Lilly on Monday; Wyeth on Tuesday; and Glaxo and Schering-Plough SGP.N on Wednesday.

The picture is unlikely to improve.

Analysts expect earnings to tumble at Glaxo, the world's No. 2 drug maker, as demand for its Avandia diabetes pill has fallen off a cliff since a safety scare last May.

Profits at Merck, Novartis and Wyeth will suffer because of competition from cheap generics.

Unlike some big pharma rivals, Novartis is taking decisive action to diversify away from slow-growing prescription drugs into more resilient health-care areas.

Earlier this month, it announced plans to buy up to 77 percent of U.S. company Alcon (ACL.N) from Nestle (NESN.VX) for $39 billion to boost its eye care business.

Diversification does not come cheap, but Morgan Stanley analysts believe drug makers need to invest in other areas, including vaccines, diagnostics and consumer and animal health, as the old blockbuster model starts to fade.

The over-arching threat is approaching patent expiries that will kick in with a vengeance in 2010-2012, taking down many of the world's top brands, including the biggest of them all, Pfizer's $12-billion-a-year Lipitor cholesterol pill.

Shareholder skepticism that pharmaceutical companies can successfully reinvent themselves during this transition is the fundamental reason for record-low valuations of one-time growth stocks.

Pfizer shares, for example, now fetch just eight times expected 2009 earnings and yield a whopping 6 percent with the company's dividend. UBS calculates that price/earnings ratios in the European drugs sector have fallen 50 percent since their 1999 peak.

To be sure, those dirt-cheap valuations and strong yields are luring some investors. Chris Armbruster, research analyst at Al Frank Asset Management, said his firm had 10 drug makers on its "buy" list, particularly favoring Merck and Schering-Plough.

"The valuations they have had historically have been based on steady cash flows, steady earnings," Armbruster said. "We think that in the years to come that these companies will be able to show that kind of reliability again."

But for now, recent high-profile blow-ups for drugs still protected by patents have exacerbated investor nervousness. The recent collapses of both Avandia and cholesterol fighter Vytorin, from Schering-Plough and Merck, were bolts from the blue.

"You used to be able to predict revenues virtually down to the last penny once a drug reached the market," said a veteran industry executive, who requested anonymity. "Now that's gone out of the window."

(Additional reporting by Ransdell Pierson; Editing by Lisa Von Ahn)