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It's Pharma Time: Why Merck and Lilly Are Buys, but Not Pfizer.

Barron's · 01/06/2023 20:56
By Jack Hough

My 2023 biotech outlook calls for continued momentum in name changes. I just need to figure out what the stocks will do.

Last year, Respira Technologies became Qnovia. It's run by a former tobacco executive with vape experience, and it's developing an inhaled nicotine platform for quitting smoking. On one hand, I found years ago that a pretty good platform for that is just to not inhale any more nicotine. But on the other hand, going from Q straight to N in a company name sounds clinically promising.

A biotech once called CytRx fell from over $4 a share in 2021 to 10 cents last September, before changing its name to LadRx (ticker: LADX). Still 10 cents. Bone Therapeutics is now BioSenic (BIOS.Belgium) and still into bone therapeutics. The industry blog FiercePharma calls this and many other examples a "biopharma name-changing craze."

The biotech industry could use a fresh look. The SPDR S&P Biotech exchange-traded fund (XBI) gained 32% in 2019, and then 48% in 2020, before sliding 20% in 2021, and another 26% last year. Now it's back to a price it hit in 2015. There was a rush of companies going public when shares were riding high. Many weren't only prerevenue, but also not yet testing in humans. With interest rates rising, investors have favored pharma stalwarts instead.

Geoff Meacham, who covers drugs for BofA Securities, wonders if Big Pharma will sell off when the economy strengthens, but that doesn't seem likely during the first half of this year, he says. Favor quality companies with good growth prospects, he says. This past week, he downgraded Pfizer (PFE) to Neutral from Buy, and did just the opposite with Merck (MRK), raising it to Buy.

Pfizer faces a double whammy. It got a revenue lift for the ages during the pandemic, but this year it could see a massive decline in sales of Paxlovid, its Covid-19 treatment, and Comirnaty, better known as the Pfizer vaccine. The brand name, just in case you're wondering, is a mashup of Covid, community, immunity, and mRNA, a genetics acronym. Meacham puts Pfizer's Covid comedown at $32 billion. The Street says $24 billion. The company did an estimated $100 billion in total revenue last year.

"We've always been skeptical that people are going to regularly get boosters every year, especially if the new strains of Covid or new variants aren't that worrisome, and people are already vaccinated," Meacham says. Whammy No. 2 for Pfizer is that it faces an estimated $17 billion in revenue declines from the loss of patent exclusivity on key drugs from 2025 to 2030.

Merck faces an even bigger patent cliff. Its Keytruda for cancer, one of the top-selling drugs in history, could do $24 billion this year, or 40% of company revenue. And it's expected to peak around $30 billion a year. But it will lose exclusivity beginning in 2028. Management's strategy has been to promote using the drug as the backbone of a long list of combination therapies. Those could sell well long after sales of the stand-alone drug decline.

Merck goes for 15 times this year's projected earnings, and Pfizer 10 times. Eli Lilly (LLY) goes for more than 40 times, and is up more than 300% over five years, but remains one of Meacham's favorites. Its drug for diabetes, which could win approval for obesity this year, delivered up to 22.5% weight loss in trials, making it more effective than Novo Nordisk's (NVO) drug, which is already approved for weight loss. The Lilly drug is also being tested for obesity-related diseases of the heart, liver, kidneys and more.

"To put it in perspective, a patient on this drug that is nondiabetic, just, you know, a straight obese patient, their blood pressure, their heart rate goes down more than if they're on a heart rate med," says Meacham. "Their lipids crash almost more than if they're on a statin. Their blood sugar goes down as if they're on a diabetes medicine. So, it isn't just about the weight."

The breadth of these trials could both increase the drug's potential patient population and make insurance companies more likely to pay. Meacham says that making only moderate assumptions about the drug's success, it could eventually bring in $100 billion a year in revenue, making it by far the best-selling drug ever. Total sales for Eli Lilly this year are pegged at just over $30 billion.

A year ago in this space, I mentioned Devon Energy (DVN), a leading U.S. shale driller, whose stock was up 181% over the preceding year. Its CEO had vowed to hold the line on production despite high crude oil prices. The stock since then has returned another 43%, versus a 12% decline for the S&P 500 index. But surely energy stocks, after two consecutive years of shining, can't three-peat in 2023. Can they?

Raymond James is mighty bullish. U.S. crude production will increase just 0.8% this year, it reckons. But OPEC+ cuts will offset that. Non-OPEC producers will grow output by 0.9%, but that won't be enough to keep up with a 1.4% rise in global demand. Put it all together and Raymond James expects Texas crude to rise from a recent $74 a barrel to a year-end price of $110, averaging $100 along the way. The firm's analysts call Devon a Strong Buy and say it will hit $87, for a further gain of 42%.

Too bullish an outlook after such a wild rally? Definitely. Unless of course it pays off, in which case I had a feeling it would. It's my highest-conviction noncommittal.

Write to Jack Hough at jack.hough@barrons.com. Follow him on Twitter and subscribe to his Barron's Streetwise podcast.

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January 06, 2023 20:56 ET (01:56 GMT)

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