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Straight Dope on Drug Stocks

Where to look for upside surprises and who's likely to disappoint in the upcoming round of reports.

This column was originally published on RealMoney on Oct. 17 at 12:02 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.

I expect a generally constructive reporting season for the major pharmaceutical companies, although special factors may cloud the impact of near-term earnings for certain stocks.

It's been an eventful quarter for the big pharma players, with a variety of big product approvals and setbacks, as well as unusual generic situations and some major management changes. I believe that several of these issues will overshadow the earnings outlook in the near term for

Bristol-Myers Squibb

(BMY) - Get Bristol-Myers Squibb Company Report

,

Pfizer

(PFE) - Get Pfizer Inc. Report

and

Merck

(MRK) - Get Merck & Co., Inc. (MRK) Report

. I expect

Wyeth

(WYE)

to continue to deliver consistent results that are generally in line with forecasts.

I expect the greatest impact from earnings releases to be on the shares of

TheStreet Recommends

Schering-Plough

(SGP)

and

Eli Lilly

(LLY) - Get Eli Lilly and Company (LLY) Report

.

Bristol-Myers

The short-term play that is the toughest to call is Bristol-Myers. Its sales of Plavix, the second-biggest selling drug in the world, which it markets in the U.S. in cooperation with discoverer

Sanofi-Aventis

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, have been disrupted by the launch of a generic version in the U.S. market by the Canadian company

Apotex

. In late August, a federal court issued a preliminary injunction forcing Apotex to halt distribution, but it allowed sales to continue of shipments of the generic that were already on the market.

Sanofi says Apotex already may have sold enough of the unbranded pills in the U.S. to satisfy all market demand through the end of the year. This, plus the debut of generic versions of Pravachol earlier this year, should cut Bristol's EPS by about 50% from last year.

A key consideration for Bristol will be the extent of the inventory backlog for Plavix and guidance on the anticipated time frame for this situation to normalize. Another complicating factor for Bristol is the turmoil at the top of the company, as it recently ousted its CEO. The announcement of a new management team is likely to be an important driver for the stock in the near future.

Merck

There is a lot happening at Merck these days. The company is grappling with the first full quarter of generic competition to its valuable cholesterol drug Zocor, which is likely to depress earnings by more than 20% compared with last year, with forecasts at 49 cents a share. Management has withheld formal quarterly guidance due to uncertainty over the extent of the damage.

The company is ramping up distribution of Gardasil, a recently approved vaccine against the virus that causes most cervical cancers and genital warts. It is expected to be a major contributor going forward, but the pace of market uptake and reimbursement issues may prevent investors from gaining much confidence in this franchise for at least another quarter. The company announced Tuesday morning that the FDA approved its novel diabetes treatment Januvia, which should support the stock.

I have a positive bias on the stock, as I believe expectations on Zocor are reasonably conservative, and greater upside is likely to come from new products over the next several quarters.

Pfizer

Pfizer's earnings are expected to decline this quarter, as the generic versions of Merck's Zocor are likely to cut into sales of Lipitor, the world's best-selling cholesterol buster. Although the full impact on Lipitor will take several more quarters to materialize, I expect investors will quickly extrapolate from short-term developments. On the positive side, the debut of a generic version of Pfizer's Zoloft was delayed by about two months this quarter, and it rolled out the new drugs Exubera and Chantix.

This will be the first full earnings report for new CEO Jeff Kindler; greater clarity on his strategic vision isn't expected until the company's late November analyst meeting. As a result, I don't believe the new management team will want to set too high a hurdle for short-term earnings, with quarterly forecasts at 45 cents a share.

Schering-Plough

Schering-Plough is one of the more interesting recovery plays in the group because of the shot in the arm it has gotten from the cholesterol drug Zetia, and Vytorin, a combination of Merck's Zocor and Zetia. They appear to be on a strong growth trajectory and have among the largest upsides of any new products in the industry.

Schering has settled the federal case against it for allegedly overcharging Medicaid and marketing its drugs for unapproved uses, and its struggling interferon franchise appears to be firming up. A strong earnings report would contribute greatly to its turnaround. The consensus is for modest year-over-year EPS growth to 15 cents a share.

Eli Lilly

Lilly shares have been held back by concerns over its large Zyprexa franchise (the antipsychotic has been shown to cause excessive weight gain, leading to diabetes and other problems) and its failure to gain regulatory approval for Arxxant. I believe the impact from Arxxant is a longer-term concern that other pipeline projects will make up for. A positive, revenue-driven earnings surprise this quarter would improve investor sentiment.

Zyprexa sales began to stabilize last quarter and they need to continue this positive trend. I also expect competitive inroads by Cymbalta and continued growth in Alimta and Forteo sales to further support organic growth. Management sounded a relatively cautious tone for guidance last quarter, forecasting EPS in a 77-cent-to-79-cent range. The consensus is currently at 79 cents.

Wyeth

I expect Wyeth to report a solid quarter due to the health and diversity of its product portfolio. The company isn't facing any major challenges from generics this quarter and management raised full-year guidance at last week's R&D meeting. The source of this upgrade was somewhat unspectacular, though -- a retroactive R&D tax credit for the full year.

The company was also very optimistic that Enbrel and Prevnar sales will come in strong this quarter and continue to grow. In addition, it recently filed with the FDA for approval of the antipsychotic Bifeprunox. I don't expect any major surprises from Wyeth in the report following last week's management update. The consensus forecast is 80 cents a share.

At the time of publication, Michael Latwis held none of the stocks mentioned, although positions may change at any time.

Latwis has directed health care content at TheStreet.com Professional Products. He also has worked at Barclays Wealth management division and was previously associated with Lazard Freres and Fiduciary Trust. Latwis covered companies in the pharmaceutical and specialty pharmaceutical sectors as well as biotech, medical technology, healthcare services, retail and media stocks. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Latwis appreciates your feedback;

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