Pfizer Inc. and Merck & Co. . will announce fourth-quarter results this week, but what investors will be most interested in are the companies' forecasts for the year ahead.
Both companies have to grapple with the expiration this year of patents on their largest products. The expirations will clear the way for generic producers to enter the market, squeeze the revenues of the big brand-name pharmaceutical companies, and spoil their fat profit margins.
Pfizer has recently lost patent protection in the United States for its anti-cholesterol pill Lipitor. The blockbuster drug produced $10.7-billion (U.S.) in revenue in 2010, representing 16 per cent of Pfizer's annual revenue.
"The loss of exclusivity of Lipitor in 2011 is shaking the foundation of the company," says Damien Conover, an analyst with Morningstar Inc. Adding to the turmoil, during the next three years, Pfizer will lose protection on several other big-revenue generators, including Geodon, which is used to treat schizophrenia, Celebrex, prescribed for arthritis, and Detrol, used to control an overactive bladder.
Although Pfizer has more than 90 new drugs in the pipeline, most are in the early stage of development, Mr. Conover adds.
In August, Merck will lose protection in the U.S. for its asthma and allergy treatment Singulair. The drug produced $5-billion of the company's $46-billion in sales in 2010. Many investors are worried about the strength of the company's drug-development pipeline after it had to unexpectedly cancel two important drug trials last year.
The other two giant pharmaceutical companies, Bristol-Myers Squibb and Eli Lilly & Co., face a similar ticking clock on key patents, which will make 2012 a "trough earnings year" for the sector's biggest players, notes Christopher Schott, of JPMorgan Chase & Co. But looking out to 2013 through 2017, he forecasts that the sector will deliver compound annual share profit growth of 7 per cent, as the rate of patent expirations slows, new products come to market and the companies use their cash flows to buy back more shares.
Mr. Schott has "overweight" recommendations on both Pfizer and Merck. He cites Pfizer's low price-to-earnings multiple of 9.7 times estimated 2012 share profit, the high dividend yield of 4.1 per cent and anticipated new products coming to market.
Merck looks the best positioned among the major pharmaceuticals to boost growth in the coming years, thanks to its diabetes drug Januvia, its robust vaccine franchise and several new drugs in late-stage testing, Mr. Schott notes. Merck also enjoys one of the lowest valuations in the sector, at just 10 times estimated 2012 earnings.
While the majority of analysts have "buy" recommendations on both Pfizer and Merck, investors aren't so sure. The companies' relatively large dividend yields are attractive, but the broader trends are negative.
Big U.S. pharma stocks are trading at some of their lowest valuations in decades, as government austerity measures threaten their performance for years ahead. Western governments, which pay for the lion's shares of health care costs, are increasing their use of cheaper generic drugs. In the U.S., for example, legislation last year vowed to cut $500-billion out of health care costs over 10 years. On top of this trend, the industry faces heightened regulatory scrutiny following some high-profile safety recalls, including Merck's drug Vioxx.
The new environment has thrown into question the pharmaceutical sector's reputation as a haven for investors in volatile markets. Pfizer's report, on Tuesday, and Merck's, on Thursday, are unlikely to ignite a spark under the stocks. Pfizer is expected to post a 5.5 per cent decline in revenue and 56 per cent drop in profit for the fourth quarter. Merck is expected to squeeze out revenue growth of 3.4 per cent and swing to a $2.9-billion profit after a $532-million loss a year earlier.