The Real Cure

	Elliott Gue PF Newsletter.com
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Pharmaceuticals have been the come-what-may stocks—up to now. Below we weed out the promises from the performers.

Big drug companies were like utilities. They had steady sales whether the economy was good or bad.

But like so many utilities in the go-go 1990s—many drug company executives ditched their tried and true, "boring" moneymaking strategies and bought into the "aggressive accounting" and investor hype that boosted their stock options.

While many Wall Street pundits continued to promote Old Guard pharma like Merck, Pfizer and Bristol Myers as values, we saw that these stocks were overpriced, their drug pipelines narrow and their patents expiring.

In addition, threats to big revenue drugs from pending regulatory and legal actions--as documented in PF's daily online companion By George—underscore why investors need to be wary of Old Guard pharma. In the last 12 months, big pharma has lost big money for investors who didn't heed our analysis.

We do like some companies in this space--just not the washed out headliners. They range from the big drug producers of both patent and generic drugs to the hybrids that also successfully develop medical devices and consumer goods.

What's more, these stocks are still bargains on their way up, rather than former high-rollers that are skidding into the bargain bin.

Better Biggies

During the past five years, more than $35 billion worth of prescription drugs lost their patent protection and were subject to generic competition. Even the industry estimates a whopping $65 billion in expirations between the end of this year and 2010.

What's worse, there are few blockbuster drugs that can replace these lost revenues. This wave of expirations represents a significant hit to the bottom line of most major pharmaceutical companies.

But not all big drug companies are exposed to the patent expiration problem. Switzerland-based Novartis already has several major blockbuster drugs on sale including Lamisil for the treatment of fungal infections and Diovan for the treatment of hypertension. Few of the company's best-selling drugs are scheduled to lose patent protection in the next few years.

Novartis also wins major points for its strong pipeline of promising new drugs under development. In all, it expects to submit about five new drugs for US Food and Drug Administration (FDA) approval in 2005.

Even better, Novartis may actually benefit from the coming wave of patent expirations. The company recently acquired US generics producer Eon Labs and two German generic drug manufacturers.

These acquisitions make the company the world's largest generics drug company; all those drugs coming off patent in the next five years represent potential new markets for Novartis. Buy Novartis below 51.

Last year's megamerger between France's Sanofi-Synthelabo and Switzerland's Aventis created one of the most promising big drug companies in the world, Sanofi-Aventis.

More than half of the company's annual sales currently come from five key products, including Plavix used to treat cardiovascular disease and stroke victims and Aprovel for high blood pressure and certain types of kidney disease. Like Novartis, few of Sanofi's major drugs are going off patent in the next few years.

But that's just icing on this cake. More important are the cost savings from last year's merger and one of the industries most promising drug pipelines.

Management is currently targeting about 1 billion euros ($1.35 billion) in cost savings, resulting from the merger. Look for streamlining at Aventis to produce the bulk of the cost savings.

One of the most promising drugs in Sanofi's pipeline is Acomplia, an anti-obesity drug that's current in late-stage trials. In total, there are more than 50 compounds in the pipeline at varying stages of development. Buy Sanofi-Aventis below 45.

Like many large German conglomerates, Growth Portfolio Holding Bayer was once a hodge-podge of unrelated business lines with little core, strategic focus. But in the past few years, management has refocused attention onto Bayer's core business lines, including pharma and chemicals.

Last year, Bayer began to bear the fruits of its restructuring initiatives. The company swung to a nice profit after losing money in 2003. In the fourth quarter, revenue growth began to ratchet higher.

But the most exciting development for Bayer in recent months is a new drug it's co-developing to treat renal cancer. Early indications suggest it could be a big winner. Buy Bayer up to 40.

Go To Generics

In the generics business, bigger is normally better. Contrary to popular belief, when a new drug comes off patent, generics aren't simply dumped on the market by hundreds of generic manufacturers.

Generics must, like branded pharmaceuticals, receive approval from the FDA. The first company to receive generic approval gets a 180-day exclusivity period on that drug. This is like a mini-patent, allowing the generic drugmaker to charge higher prices during that six-month exclusivity.

Bottom line: Companies with the size and research capability to quickly develop generic formulations and win approval have a distinct advantage.

Israel-based Growth Portfolio member Teva Pharmaceuticals is second in size only to Novartis' generics division. The company has a huge research staff and very modern manufacturing facilities; this has allowed Teva to grab 180-day exclusivity on several major drugs coming off patent in the last few years.

Teva has also been focusing its generic business on injectable drugs—these drugs are harder to manufacture and there are fewer generic competitors.

Last, Teva has one branded patent-protected drug on the market, Copaxone, which recently got a huge boost when an MS drug co-developed by Elan and Biogen Idec was pulled from the shelves. This should result in higher Copaxone sales and less competition for the drug on pricing. Buy Teva up to 36.

Growth Portfolio denizen Dr. Reddy's Laboratories is another long-term winner in the generics business. The company is based in India where it's able to hire scientists and research staff at a fraction of the cost similar staff would cost in the West.

In addition, Reddy's has proven its ability to bring blockbuster new generics to the market quickly. In 2001, the company was the first to bring a generic version of Prozac to market, capturing the 180-day exclusivity period on the drug.

In recent years, Reddy's has moved beyond its traditional generics business to develop new, branded drugs. Promising drugs in the pipeline include a novel treatment for cardiovascular disease currently in trials. Buy Dr. Reddy's in increments up to 25--and be patient.

Watson Pharmaceuticals has taken a more cooperative approach to developing new generic drugs. The company has managed to garner exclusivity on several drugs by working to produce "authorized-generics."

This generic class is co-developed with the big pharma firms that have drugs moving off patent. With the help of the original producer, it's easier and cheaper to bring a generic to market. Watson also produces a lot of its drugs at manufacturing facilities in India. This is another major cost saver for the company. Buy Watson below 34.

Gotta Have Hybrids

Johnson & Johnson has been a solid performer for many years. The company is a hybrid of a medical, pharmaceutical and consumer products company.

On the healthcare front, J&J's drug eluting stents, which are used to prop open clogged arteries, capture most of the headlines. But the company also has several other major product lines including blood glucose monitoring systems and bone reconstruction equipment.

What's more, J&J's recent purchase of Guidant will help fill out this segment of the business; Guidant is a leading producer of pacemakers and defibrillators. On the consumer products front, brands like Neutrogena and Aveeno have been reliable growers through the years. Buy Advantage Portfolio recommendation J&J under 70.

Next up is Baxter International, which manufactures medical products and makes a series of drugs that are delivered intravenously, including antibiotics, anesthetics and pain management medication. In addition, the company makes products manufactured from blood plasma to treat diseases like hemophilia.

Baxter fell on hard times a few years ago, mainly due to poor pricing and lots of competition in its core blood plasma processing and intravenous drugs businesses. But many of these competitors have now shuttered manufacturing facilities and exited the business.

What's more, Baxter has the world's most advanced manufacturing facilities for many of its key drugs. Pricing and profitability are back on the mend. Buy Baxter up to 40.

Elliott Gue will be available to take your questions until Thursday, March 31. Please use the form below to submit your questions.