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The Coming Year: After Last Year's Big Run-Up, a Few Red Flags for Drug Stocks

Here's the ultimate guide to what to watch in pharmaceuticals this year.

Every December for the past several years, investors have marveled at the performance of drug stocks. They think the stocks look tired. But then, they act like they're on sustained-release amphetamines.

"It's hard to believe that anything more could go right," says Ron Nordmann, a partner at New York money manager

Deerfield Management

. "Most money managers try to get too cute and stay away from sleepy old pharma. But at the end of the day, the 15% growers are extraordinarily well-rewarded." He worries nonetheless: "As we come into 1999, there are caution signs on the horizon."

So this year is no different from the last several. After the run-up in 1998, when the

Amex Pharmaceutical Index

rose 46%, outpacing the

S&P 500

, investors wonder if the drug stocks will do well again. They are tempted by little pharma where more modest products can make big impacts. Or underperforming biotech, as hard as that is to believe.

Who knows what will happen. But what can be anticipated are some of the most important factors that will affect the shares of the big pharmaceutical stocks this year.


(MRK) - Get Free Report

This perennially controversial biggest of the big pharmas has a difficult year ahead. The question is how badly will patent expirations in 2000 and 2001 on products that accounted for 25% of Merck's pharmaceutical sales in 1998's first nine months hurt?

Merck's "battle to establish its new products" is 1999's story, says Alex Zisson, pharmaceutical analyst for

Hambrecht & Quist

, which hasn't participated in Merck underwriting. Zisson rates Merck a neutral.

Asthma drug


is off to a solid start, but head remedies


(a hair-grower) and


(a migraine drug) aren't doing well.


, a heart therapy, has only the faintest of pulses.

The company's key new product is


, its super-aspirin. Approval is considered a foregone conclusion. But watch whether the

Food and Drug Administration

grants Vioxx expedited review, meaning it could be launched midyear, or a standard 12-month review. Also, how will the launch of


(MTC) - Get Free Report



(PFE) - Get Free Report


go? The recently approved Vioxx competitor has observers betting it will become a multibillion-dollar pill annually. That means that Merck is like Monsanto's and Pfizer's Corsican Brother (as imagined by

Cheech and Chong ). If Celebrex is a bust, Merck's stock will feel the pain.

Bonus issue: The continuing market-share battle between the cholesterol lowering class called statins. Merck's


is still growing, although it has suffered from the spectacular success of competitor


, marketed by



and Pfizer. Zocor had a 26.5% market share at the year's end, according to

ING Baring Furman Selz

, compared with Lipitor's 42.7%. If the category slows down, Merck holders need to watch out.


"It's hard to see what could go wrong within, say, a two-year timeframe," says Deerfield Management's Nordmann, who as a policy declines to disclose his positions. "But the investment argument against is that

Pfizer's success is widely and wildly anticipated by the current stock price."

Nevertheless, there are stories that could move Pfizer's stock. The company will co-market Celebrex with Monsanto. A Celebrex success could have stock holders singing.



could be a sour note. At an annualized rate of about $500 million domestically and holding, according to ING Baring, it's not a successful drug compared with expectations. People think that Wall Street understands that, but does it really?

Bristol-Myers Squibb

(BMY) - Get Free Report

Wall Street wants Bristol to spin off its medical products division,


and perhaps even its

Mead Johnson

nutritionals business. If Bristol does unload Zimmer under favorable terms or, even more boldly, announces a dramatic restructuring, it could be good for the shares. See: "Rules of the Street: Pink slips equal green stock prices." Bristol didn't return a call seeking comment.

Also, Bristol's statin,


, which closed the year with a 16.8% market share, needs to hold on.

Its diabetes drug,


, will go off-patent in March 2000. The drug has close to $1 billion in sales. If BMS can sneak its extended-release version, in development with



, onto the market before then, it won't suffer, according to H&Q's Zisson, who rates the stock a buy. His firm hasn't participated in underwriting for Bristol.

Bonus issue: Watch for a rising profile of


, a hypertension drug that could become a blockbuster. It's set for launch early in 2000.

Eli Lilly

(LLY) - Get Free Report


The big concern is


. When does it go off-patent? 2001? 2003? Some other year? Wall Street will get some clarification this year. In addition, late this month a challenge to Lilly's Prozac patents brought by generic drug company

Barr Labs


will go to court. The progress of this case will shadow Lilly's stock.

Wall Street also likely will hear about the progress of



version of Prozac this year.

Also, Lilly has a major launch coming up in the year's second half with


, a diabetes drug in the same class as Warner-Lambert's


. Rezulin has been dogged by concern about liver toxicity. Actos' success depends on whether it's hit by similar concerns.

SmithKline Beecham's

(SBH) - Get Free Report


might beat Actos to the market by a couple of months; its reception will offer an indicator for Warner and Lilly.

Bonus issue: Can schizophrenia drug


, selling at an annualized rate of about $900 million now, according to ING Baring, continue its fast growth?



"It's really an amazing company. They've posted very steady mid-teens growth with fewer products than almost anybody. It's incredible that they've been able to sustain that growth rate with only a couple of new products in the last decade," says Deerfield Management's Nordmann.


grows like ragweed, and the company buys back stock. Can it last?

Claritin will come off patent sometime next century but exactly when is up in the air. In 1999, Wall Street will get clarification on this issue, says Zisson, who rates the company a neutral. H&Q hasn't participated in Schering-Plough underwriting.



, the recently launched hepatitis C therapy, is doing spectacularly well, selling at an annualized rate of about $350 million a year. Will it continue to grow?

Bonus issue (a perennial one for SGP): If things go south for Schering-Plough, does it become a merger candidate?

American Home Products


"They've been dumped at the altar two times," says Zisson, recalling failed mergers this past year with SmithKline Beecham and Monsanto. (He rates it a buy. H&Q hasn't participated in American Home underwriting.) The analyst says the company has signaled it would still like to make an acquisition.

Pharmacia & Upjohn


perhaps? Or even a MTC or SBH redux, believe it or not. Monsanto and SmithKline won't comment. A spokesman for American Home says, "We believe American Home does not need a merger, but we remain open to opportunities as they may arise."

The company is launching a series of what could turn out to be multihundred-million-dollar drugs, but not blockbusters. These include


, an organ-transplant drug, and


, a sedative. How well these will do?

Bonus issue: the sustainability of its rheumatoid arthritis drug


, marketed with developer



? It's at a $100 million plus annualized rate and is the subject of widely divergent expectations on Wall Street.


"It's a one-and-a-half trick pony," says money manager Nordmann. But it doesn't have any new major drugs in its pipeline.

Lipitor has "exceeded everybody's greatest estimates," says the money manager. Will it keep going?

More importantly, will Lilly's Actos and SmithKline's Avandia cause the market for the glitazone class of diabetes drugs to grow more rapidly? Or will one or both be safer on the liver, an advantage that could wipe out Rezulin?

Bonus issue: At some point, Warner, under the terms of its deal with Pfizer on Lipitor, gets a "quid" from its partner. Will investors find out what it will be in 1999?

Pharmacia & Upjohn


for incontinence had a solid launch, grabbing over 55% of the market. Will competition from



Ditropan XL

boost the market or hurt it?



, a glaucoma drug, continue to sell well?

Bonus issue: "The rest of the product line is really old and really mature," says Nordmann.