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Disquiet in King's Realm

The drug company's stock is near a 52-week high, but Wall Street sees challenges ahead.

King Pharmaceuticals'

(KG)

shares have nearly doubled in less than five months, reaching levels unseen since May 2004.

Before finishing Wednesday at $14.70, 27 cents below its 52-week closing high, the stock hit $14.99 intraday. It's fetching more than any price level achieved during

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ill-fated romance of King,

a courtship that ended in February.

The rising stock reflects investors' reaction to efforts by King's new management to cut costs, improve inventory management, sharpen their strategy and clear up a series of problems that

forced the company to restate more than two years' worth of financial reports. In early August, King reported second-quarter results that

easily beat Wall Street's estimates.

Even so, there are plenty of hurdles in the way of a full-fledged comeback. Many analysts have raised their earnings estimates for 2005 and 2006, but they haven't changed their cautious stock ratings. Nine are neutral, according to Thomson First Call. Two have buy recommendations, and one advocates selling the shares.

Attack of the Generics

Wall Street is essentially neutral because King still has several unresolved issues, such as investigations by the Department of Health and Human Services and the

Securities and Exchange Commission

. The company has set aside $130.4 million in reserves as it tries to settle the investigations.

Analysts are also jittery about future matters, such as generic and brand-name competition and King's need to develop new drugs.

"King is facing competitive challenges to four of its top five drugs over the next one to three years, clipping revenue and earnings-per-share growth from 2006 through 2009," says Ian Sanderson of SG Cowen in a recent report, in which he called King's shares "unattractive at current levels." He doesn't own shares, but firm was involved in a King public offering within the last three years.

Generic competition through 2009 could hit products that should account for 60% to 65% of this year's revenue and 70% to 75% of this year's earnings per share, Sanderson says.

The most immediate issue involves Skelaxin, a muscle relaxant, which is King's second-best-selling drug. Skelaxin contributed $238.6 million to King's $1.3 billion in sales last year.

In assessing King's prospects for the rest of 2005, Sanderson calls Skelaxin a wild card. He says the drug could contribute $260 million to $280 million for the full year. King is opposing petitions to the Food and Drug Administration by three companies to sell a generic version of Skelaxin. Sanderson says the FDA could rule soon, and he worries that at least one of the competitors might slip through King's patent defense, putting Skelaxin sales at risk in the fourth quarter.

If Skelaxin dodges generic competition, next year's earnings could be $1.18 a share. That's according to Michael Tong of Wachovia Securities, who recently issued a research report in which he upheld his market-perform rating. But if copycat versions reach the market early next year, King's 2006 profit could plunge to 64 cents. Tong says there's an 80% chance the FDA will favor the generic companies. He doesn't own shares, but his firm says it expects to seek or receive investment-banking-related compensation in the next three months.

More Competition

A bigger, though less immediate, concern is Altace, a blood pressure reliever that is King's biggest seller. Altace accounted for $347.3 million, or 27%, of last year's revenue. Sanderson says Altace should retain patent protection until late 2008 or early 2009, assuming King wins a patent challenge filed by a Canadian drugmaker that's scheduled to go to trial Sept. 12.

Sanderson expects King to win the lawsuit, but he says Altace faces other pressures. The drug's prescription-growth rate slowed in the second quarter compared with the same period last year. Generic drugs from the same class of compounds and brand-name competitors from a different class of hypertension drugs took their toll, he says. Plus, the upcoming Medicare drug benefit plan could chew into sales.

Even with slower growth, however, analysts predict that Altace and Thrombin-JMI, a wound-healing drug used in hospitals, will form the foundation for King during the next few years.

Another King drug, Sonata for insomnia, is facing

ferocious competition. King took a one-time intangible asset-impairment charge of $126.9 million in the second quarter to reflect the tougher market.

For several years, Sonata has been a very distant second to Ambien from

Sanofi-Aventis

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. But if recent U.S. prescription trends hold up, Sonata will be third behind a new option: Lunesta from

Sepracor

(SEPR)

.

Takeda Pharmaceuticals

enters the market later this month with Rozerem. Sanofi-Aventis is seeking FDA approval of a controlled-release version of Ambien, and the team of

Pfizer

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and

Neurocrine Biosciences

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also has an insomnia drug under FDA review. Considering that Sonata produced $60.4 million, or 4.6%, of corporate sales last year, it won't be playing much of a role in the future.

Given the known competition and the uncertainty over patent challenges, analysts say King still has a long way to go. Although he was impressed by the second quarter and has raised his full-year profit estimate, Robert Hazlett told clients recently that "these changes will not do much to aid King's operations over the long haul," because the company's turnaround plan "will likely take some time to execute."

Hazlett, of SunTrust Robinson Humphrey, is neutral on the stock. He doesn't own shares, and his firm has a non-investment-banking relationship with King.