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BERGEN-BRUNSWIG, McKESSON ARE BACK IN INVESTMENT FAVOR; CHAINS AND WHSLRS. FLOURISH IN FIRST QUARTER; RORER AND GENERICS STRONG AMONG MANUFACTURERS

Executive Summary

Bergen-Brunswig's 32% net gain (to a March 31 close of 26-5/8) and McKesson's 22% net advance (to 32-1/4) in 1988 first quarter trading exemplify the strength of the stock market's renewed interest in drug distribution. The two wholesaler stocks had ended 1987 with net losses. Their gains prior to the October debacle were not as large as gains by the drug manufacturing issues and the fourth quarter drop left them on the downside for the year -- Bergen, off 1/2 to 20-1/8, and McKesson down more sharply (5-1/4 to 26-1/2). Bergen's big gains in the first quarter of 1988 have carried the stock back to a level near its high point for 1987. Bergen, in fact, is the issue closest to its 1987 high-water mark among the 47 stocks in the "F-D-C" Index of NYSE and Amex issues. Bergen's total market valuation on March 31 was $ 354 mil. At the end of 1987, the ValueLine investment service gave Bergen a middling rating for both safety and timeliness. ValueLine predicted, however, that Bergen's effort to integrate its major purchases from 1985 and 1986 would continue to show progress and that the company's operating margins in the drug wholesale business could climb back toward the 3% level that existed in fiscal 1985. During the first quarter, ValueLine upped its rating for timeliness for purchase of Bergen stock. Similarly, in late February, an analyst with the Philadelphia firm of Butcher & Singer initiated coverage of Bergen with a strongly positive report. The Butcher & Singer report forecast earnings growth from continuing operations in the Aug. 31-ended fiscal year of 80%. Bergen is also getting a boost from a market swing back to distribution. The Butcher & Singer report states a form of that appreciation flatly, calling drug wholesaling "recession resistant," and noting that "people are likely to buy needed medications regardless of the economic climate." The Philadelphia analyst regards drug wholesaling in general as well positioned to benefit from growth by the brandname segment, generic marketing and biotechnology advances. If one or all of those segments grow, the analyst contends the drug wholesalers will benefit. McKesson has also moved up on predictions of margin improvement by its key drug business. Those predictions plus the stock's slow recovery during the final quarter of 1987 have apparently provided it with a boost in the first three months of 1988. In addition, McKesson continues to ride the crest of improved visibility for its majority owned subsidiary PCS in the rapidly advancing claims processing business. Through nine months of its fiscal year (ended on March 31), PCS was showing sales up 44% and earnings ahead 52%. The claims processing business has after-tax margins almost 10 times as great as drug wholesaling. One oddity of the market's renewed interest in the major wholesalers is that it coincides with a change in the speculative attitude of the industry itself. The merger market in the drug wholesale area has cooled so drastically from the frenzy of three years ago that Amfac's open offer of the sixth largest ($ 730 mil. annual volume) wholesaling business has failed to surface any publicly disclosed offers in three months on the market. The allure of health product distribution in a potentially unsettled economy is also evident at the retail level among the chain drug store issues. All seven chains tracked by the "F-D-C" Index had net gains for the first three months of trading. The biggest point gain was turned in by American Stores, up 11-3/4 to 62-1/4; the largest percentage gain was turned in by Perry (up 66% to 9-1/8). American Stores caught the market's attention when it decided to try its luck (and financial power) at building the largest grocery store business in the U.S. Its evolving $ 1.9 bil. bid for the Lucky chain has been accompanied by a market surge. Perry's gain was driven by the sale of its Auto Works division in mid-February for about $ 50 mil. to The Trump Group. The Michigan chain has been changing its profile and personality under a new top operating exec, David Schwartz. The top gainer among the drug manufacturing stocks during the first quarter of 1988 was the Rorer Group, up over 40% to close at 33-7/8. While losing its bid to join the ranks of the U.S. drug majors through the acquisition of Robins, Rorer gained market notoriety and a cushion of cash. For the breakup of its previous agreement with Robins, Rorer should receive a payment in the area of $ 25 mil. The publicity that the firm received as a potential merger target itself is less easy to calculate but probably much larger in value. Rorer faces a threat to its major Maalox line in the near future from the startup of TV ads for prescription treatments by SmithKline and Glaxo. SmithKline's TLC ad campaign for Tagamet began on TV the week before Easter. A similar Glaxo ad campaign to imprint the Zantac (ranitidine) name with ulcer/stomach upset treatment is reportedly ready to begin during April. Both campaigns are aimed at drawing self-treatment patients into the doctor's office for evaluation and potentially a switch to prescription medication. SmithKline, at least, is also trying to link its name to cimetidine with the general public in preparation for eventual OTC marketing. SmithKline regained about 10% of its market price during the first quarter, while Glaxo, with continuing strong results, was flat at 18-3/8. With the slow upward trend for most of the drug stocks, some analysts are starting to tout bargains. In a late March report, for instance, C.J. Lawrence analyst Lynne Pauls upped the rating for Lilly to "buy/hold." Lilly has gained a net six points in first quarter trading (to close March 31 at 84), but the stock is still way off its 1987 highwater mark of 107-3/4. Pauls credits Lilly with a careful rollout of the antidepressant Prozac. "Lilly's introductory marketing strategy, which has made physicians feel comfortable with the product," Pauls said, "has resulted in an overwhelming market response." She estimates first-year sales for the product at $ 60 mil. To avoid side-effects, Pauls maintains, Lilly is advising that Prozac be used "at approximately one-half the highest dose that was used in clinical trials." The praise for the cautious approach to Prozac is a fitting tribute for a lesson well learned at Lilly. In contrast to the aggressive introduction of Oraflex which led to the rapid success and demise of that product, Lilly's reserved launch of Prozac appears headed to building a strong, long-term franchise in the antidepressant category. The contrarian wisdom of the market for current results was reflected in the treatment of Merck and Genentech. The two companies are in an indirect competition for the most successful new product launch record with Mevacor and Activase, each estimated for first year sales of around $ 300 mil. Despite a star-studded product firmament and a well-funded and lively product development pipeline, Merck was flat through the first quarter. At least one analyst, Goldman Sachs' Frederic Greenberg, recently portrayed the continuing performance of the company compared to the market treatment as an opportunity for purchase. In a March 23 report, Greenberg reiterates a purchase recommendation. In addition to the company's product profile, Greenberg notes that at year-end, the company had cash and investment assets of approximately $ 1.6 bil. compared to debt of $ 167 mil. -- an astounding 10 to 1 ratio of cash to debt. With those resources, Merck could stop selling all products and still continue to operate for almost six months without any changes in spending patterns. Genentech has been buffeted by the debate over Medicare funding for TPA (see related story, p. 3). The company has been trying to convince the financial community that Medicare funding is not really a short-term issue for the product's use. Hospitals are complaining to the federal government about an alleged shortfall in reimbursement for the drug under existing diagnosis-related group rates, but Genetech notes that much of the use is being paid for under Medicare Part B emergency, non-admitted treatment ("The Pink Sheet" March 14, p. 5). The market's warming expectations for the generic drug industry in anticipation of Medicare Outpatient Drug Coverage were expressed in the across-the-board upward surge by generic companies (with the exclusion of Zenith, which is still under an investment shroud from prolonged difficulties with FDA). Chart omitted.

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