The Investment Column: Bank profits on pharma stocks as pressure grows on drug prices

Winners abound in biotech sector boom; Majestic Wine still has plenty of fizz

The UK's three big drug makers account for 10 per cent of the FTSE 100. GlaxoSmith-Kline and AstraZeneca in particular are among the world's biggest pharmaceuticals companies and generate billions of pounds of profit every year for reinvestment in drug development and for return to their shareholders. As an investment opportunity, they cannot be ignored, but 2006 may not prove to be as good a year for their share prices as last.

An ageing population means inexorably increasing demand for their products, but there is also relentless downward pressure on drug prices in the US, currently the most profitable drug market in the world. From this week, US pensioners without private medical insurance will have the state pick up part of the bill for their medicines. That is a boost for demand in the short term, but look behind the headline at the detail and there are myriad ways that the Federal government - set to become an indirect purchaser of more than half the medicines used in the US - will be able to use that dominant purchasing power to drive down prices to the lowest available or encourage doctors to prescribe even cheaper copies of the most popular medicines. This is likely to become one of the investment themes of the year. It is why the bulls are wrong to argue that pharmaceuticals companies shares look cheap because they trade on a lower premium to the wider stock market than at many times in their history.

The flipside to this is that companies with genuinely innovative new medicines will continue to be able to charge decent prices for them, which is why GlaxoSmithKline commands a higher stock-market rating. After a reasonable run last year, however, which included a significant amount of hype for its experimental cervical cancer vaccine, investors should bank any profits from the shares. We may discover that it will take time to convince regulators and governments that a mass vaccination programme of young girls is medically, economically or socially appropriate.

AstraZeneca, too, looks an unappealing investment for long-term investors at present, since there is a very large hole in its pipeline of new medicines. It made four product and company acquisitions last month, showing it is fully aware of the problem, but its in-house pipeline is still being thinned. A cost-cutting programme boosted its shares last year, but the low hanging fruit has all been picked. Those who have the shares should hold them in case of a takeover bid.

The much smaller Shire proved last year that it had the ambition to create a broad portfolio of lucrative, niche drugs within and beyond is specialism in the treatment of hyperactivity. The company will swing back into the black this year after 2005's acquisition-related losses, but it must prove it can market new drugs more successfully than its last big launch, of the kidney drug Fosrenol.

Winners abound in biotech sector boom

The thesis: investment in the biotech industry will pay off handsomely in 2006 in a way it has not done since the boom year of 2000. Rising stock markets will give investors confidence to seek out riskier opportunities, of which these pioneering drug developers rank among the most seductive. And disasters in the small-cap mining and oil sectors could push hardened gamblers into biotech as an alternative.

But there will be more to this revival than just froth, since the last few months have shown Big Pharma's hunger to buy promising experimental drugs - or the firms that are working on them. AstraZeneca announced three such deals on three consecutive days over Christmas, and Vectura and the privately-held Astex signed some of the biggest-ever biotech licensing deals in 2005.

The Independent has already picked Ardana for its portfolio of tips for 2006. The company has been built around the discoveries of the Medical Research Council's human reproductive sciences unit in Edinburgh, but it has also assembled a number of marketed or near-to-launch products in the area of sexual health to mitigate some of the costs of the scientific work at the company's core.

Cambridge Antibody Technology is one of the grandaddies of the sector, having already spawned one drug to have reached the market, and it should have another good year as news comes out of its collaborative work with AstraZeneca and others. We also like Vectura, an inhaled drugs company, and Acambis, which missed out last year on the enthusiasm for vaccines but which has a strong pipeline of products and the cash to generate corporate activity.

Our sells are Ark Therapeutics, whose shares leave no room for regulatory setbacks, and companies spawned by the IP2IPO biotech incubator, which could face a cash crunch in 2006.

Majestic Wine still has plenty of fizz

Its shareholders may be feeling flat after the end of the festive period but Majestic Wine still has plenty of fizz if yesterday's trading update is anything to go by. The wine warehouse retailer, which sells bottles by the case-load, had a sparkling Christmas with like-for-like sales rising by 5.2 per cent for the nine weeks to 2 January.

Strong sales of French and Spanish wines complemented the usual thirst for New World offerings, helped by the group's push into fine wines.

The company celebrated by promoting Justin Apthorp, the son of its founder and former chairman, John Apthorp, to the board as its buying director. Junior has helped to buy Majestic's wine for the past 14 years. It also made the retail director Steve Lewis chief operating officer.

Tim How, the chief executive, hopes the reshuffle will free more time for him to chase new sites because therein lies this stock's compelling growth story. With 125 stores, Mr How needs to find eight new sites this year if he is to keep his medium-term goal of 200 outlets within view.

The shares have been in this column's cellar for the past five years, but with compound earnings growth of 15 per cent likely they have yet to mature fully. At 273.5p, they trade on a profits/ earnings ratio of 15 for next year - a full-bodied premium that is well deserved. Hold.