Schering-Plough ( SGP) shares have rallied 24% in the last five weeks as approval for Vytorin, its next-generation cholesterol drug, drew near. But Bernstein Research downgraded the company Wednesday, warning investors earnings would need to dramatically improve to support current valuations. Four days after Schering-Plough received FDA approval for Vytorin, Bernstein analyst Richard Evans downgraded the company to outperform and cut his fiscal 2004 and 2005 estimates. In short, Evans said sales estimates for Vytorin, which run as high as $8 billion a year at some brokerages, are overly optimistic, despite the fact the drug is cheaper than Pfizer's ( PFE) Lipitor. In reaction to the downgrade, shares of Schering dropped $1.18, or 5.6%, to $18.86, giving back most of the 6.6% they've seen since Vytorin was approved on Friday. "To support its current share price, Schering-Plough would have to earn over $1.40
per share in 2007," said the analyst. "We see earnings power more in the 60-cent range, unless management undertakes a huge restructuring." In the analyst's view, Vytorin sales, which Schering-Plough will have to split with partner Merck ( MRK), will come in at $3.75 billion in 2006, implying 14% market share. But Evans said two-thirds of Vytorin's market share will be stolen from Merck's Zocor, which comes off patent in 2006, leaving Lipitor with 49% market share, down from an expected 54% in 2004. (None of Bernstein's analysts are compensated based on contributions to or performance in generating investment banking revenue.) Furthermore, he added that analysts are understating costs related to marketing and selling the new drug, which will result in lower-than-expected profit margins. The analyst projected the company will have to make 3.5 million sales calls at a cost of $150 each, along with a heavy promotional campaign like the one used for its Claritin franchise.
Ultimately, if the drugmaker wanted to earn between 70 and 90 cents a share in 2007, Evans said it would have to cut costs by $1.8 billion. And with shares above $19, Merck's long-rumored bid to acquire Schering-Plough and consolidate the Vytorin franchise would be highly unlikely, removing another potential catalyst for shares. In recent weeks, analysts have been hotly debating future of Schering-Plough, which is largely pinned to Vytorin and some Hepatitis C-related drugs. On Monday, Friedman Billings Ramsey downgraded Pfizer, telling investors that Vytorin will become the preferred cholesterol treatment and that its Lipitor franchise faced an uphill battle.