THE INVESTMENT COLUMN: Pharmaceuticals remain on a high

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The Independent Online
The deal-making frenzy that has gripped US drugs stocks since 1993 spilled over into the UK market in January, when Glaxo launched its pounds 9bn mega-bid for Wellcome, and continues unabated.

In the past week alone, Johnson & Johnson has been mooted as a bidder for Smith & Nephew, the keyhole surgery to Elastoplast group, and Medeva and Fisons are seen in some quarters as "in play" following the breakdown of talks between the two drugs groups. And yesterday's rumour mill had Roche of Switzerland ready to launch a pounds 14-a-share offer on Monday for Zeneca, ICI's former drugs arm spun off in 1993.

Few of these speculations are new, but what has given them increased credibility is the realisation that the outlook for the sector is not as bad as had appeared. The sea-change in sentiment can be dated to April last year, when drug shares returned to favour as fears over growth rates were seen as overdone.

It also became clear that President Clinton's healthcare reforms, which threatened to slash the pharmaceutical budget, were unlikely to get through Congress. And bids, including SmithKline Beecham's decision to pay pounds 1.5bn for Diversified Pharmaceutical Services, set the stock market alight.

The combination of these factors has seen the pharmaceuticals sector outperform the market by nearly 45 per cent over 15 months, although it remains questionable whether this pace can be maintained.

Figures from IMS International, a healthcare data monitoring group, show world drug sales up 11 per cent in the first four months of 1995. But the figures have been lifted by some markets stabilising and others rebounding and analysts doubt that this growth can continue.

That explains why Glaxo was ready to make its first acquisition for 18 years in moving on Wellcome - to capitalise on efficiency gains and increase the company's share in the tougher market conditions expected. Analysts have estimated the cost savings alone could be worth pounds 500m in a full year from combining marketing, sales and research activities.

The move is to some extent a catching-up exercise with rival SmithKline Beecham. But SmithKline's decision to buy DPS, one of the so-called pharmacy benefit managers that increasingly control the US drugs market, has taken it down a different strategic path.

NatWest Securities is forecasting the new Glaxo Wellcome will report profits of pounds 2.13bn for the year to June, putting the shares, down 3p at 752p, on a rating of 17 times. That is the forward multiple put on SmithKline's shares, up 1p at 583.5p, by the same broker's forecast of pounds 1.33bn for the year to December.

News that Glaxo Wellcome has mounted another hurdle in gaining US approval for over-the counter sales of Zantac should help sentiment, and both its shares and SmithKline's look worth holding. While bid developments unfold, the same applies to Zeneca, although any disappointment could lead to a sharp reaction in the shares.

Pelican pays

the price

Pelican, the Dome and Cafe Rouge restaurant chain, is expanding so fast at the moment it is hard to get a feel for the underlying picture. Not that investors who booked in when the company floated in 1990 will complain - the shares have grown by 60 per cent since then.

What yesterday's figures underlined, however, was the price that rapid expansion can exact from a company. Analysts believe that the sacrifice in operating profits margins from 14.9 per cent to 12.2 per cent to fuel the acquisitive push is only short-term. But plainly building the chain from 33 outlets to 63 has not been painless.

They expect margins to be restored to around 15 per cent this year, and forecast that the 64 per cent rise in pre-tax profits to pounds 4.1m announced yesterday will be comfortably beaten this year. The consensus is for pre- tax profits of about pounds 7.5m. It is a measure of the market's concern about the rate of growth that the bullish view on profits growth is not reflected in the share price. On those projections the shares, down 2p to 87p yesterday, trade on a modest prospective price/earnings ratio of 12.8, partly held back by a parsimonious yield of 3.2 per cent.

The City is plainly worried that Pelican is trying to do too much too fast, particularly following yesterday's boast from Roger Myers, the chairman, that he hoped to have 100 outlets by next March's year-end. He hinted that growth would continue after that milestone had been reached.

To try to counter the concern, he said that gearing would not be allowed to rise above a ceiling of 25 per cent. An admirable constraint, but not necessarily a realistic one. To live with that self-imposed target, Pelican will have to spit out cash. While it would be churlish to dismiss Mr Myers' confidence in the growth strategy, it would be equally wrong to ignore the intense competition in the eating-out market and the prospect of flat meal prices for some time. The market is rightly cautious.

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