Reducing portfolio positions - a wise move for 4Q and 1Q03 (page 1 of 3)

The market also witnessed a few earnings surprises, as several companies managed to beat consensus net income forecasts. However, the recurring theme was soft revenue growth, evidence that companies are tailoring their operations to suit the tougher and sluggish growth environment.

US Markets
US equity markets ended the week in positive territory despite some weaker than expected economic data and a great deal of volatility.

Declining revenues were also seen in the pharmaceutical sector, due to patent losses for blockbuster products over the past 12 months. Eli Lilly's (LLY, CSFB rating: Neutral) premier antidepressant, Prozac, continues to struggle against generic competition and Bristol-Myers Squibb (BMY, CSFB rating: Underperform) is witnessing the rapid decline in sales for its diabetes drug Glucophage, which went off patent during this year. We addressed this issue in the US Daily last week.

The industry also faces other challenges. The US has one of the most expensive healthcare systems in the world with costs continuing to rise rapidly, due to an ageing population. The US government has been trying to stem the rise in healthcare costs by proposing that generic drugs be introduced into the market at a more rapid rate. This generic drug bill could save the Americans $60 billion over 10 years. The issue over reducing healthcare costs is not new, but most attempts to cut costs have failed on account of the hefty clout the Pharmaceutical Industry carries in congress. We will standby to see how far Bush's ambitions to push the healthcare reforms will go. Thus far it seems that it will prove no more than a minor irritant for the pharmaceutical companies. It certainly is not in the government's best interest to undermine the industry's profitability, but it would seem that a balance has to be struck with regards to both the industry and the consumers.

Given the rapidly growing research and development costs, the industry's interests are clear - the protection of their products from competition for as long as possible through the filing of additional patents. This is where we believe the US government will intervene. The latest proposal is to limit the number of applications for patent extensions to a one-time 30-month extension. Current flaws in the legislation allow for companies to file for patent extensions more than once. We believe the amended legislation would serve to shorten product cycles and intensify the competition hence posing some risk to the industry.

Pharmaceutical companies have been able to grow at a 15-20% annual rate over the 1990, when new technologies and discoveries allowed for the rapid development of new therapies for diseases that prior to the industry boom were thought to be incurable. The sector looked to be a defensive and growing sector. Defensive because of the underlying demographics, which provide an expanding market, and growing because of the above average growth rates. However, it would seem that growth is abating, as the new drugs streaming into the market are essentially replacements for older generation drugs or new entrants into an area for which drugs are already on the market. The increased competition and the wide range of diseases covered by the existing drugs mean less and less business opportunities for the drug makers.

In order to weather the storm, the drug companies will be forced to find ways to further reduce costs and also to fill their pipelines. We believe a likely scenario could be a wave of consolidation, as was witnessed in the early 1990's with Pfizer having got the ball rolling with the Pharmacia acquisition this year.