WYE: WYE a decent buy and hold

Wyeth Pharmaceuticals I. Introduction According to Value Line, Wyeth Pharmaceuticals is "a leading manufacturer of prescription, over-the-counter, and proprietary drugs". Founded in 1926, Wyeth is considered the leader in women's pharmaceutical care "with its postmenopausal hormone therapies and oral contraceptives" (www.wyeth.com). The Company is has its headquarters in Madison, New Jersey but Wyeth prides itself on the 50,000 people that the Company employs in more than 100 countries. Some of Wyeth's most recognizable and popular products include: Robitussin (cough syrup), Advil (pain reliever), Dimetapp (children's cold/flu/allergy syrups), Effexor (selective serotonin and norepinephrine reuptake inhibitor [antidepressant]). The current image of the future drug industry is that of positive, though less steep, upward trend. "Prescription drug sales in the U.S. are expected to grow in the year ahead at the slowest pace in decades, and overall global pharmaceutical growth is likely to decline slightly" (Appendix B). Due to patent expirations, political promises of lower drug costs, Chinese drug imports, and the complexity of discovering new drug formulas, the pharmaceutical sector is looking at a decrease in growth relative to today's market. Patent expirations open the market to generic versions of drugs that can be produced and sold at a lower cost, undercutting the branded prescriptions, thereby limiting the gains of prescription drug manufacturers (Appendix B). According to Value Line's Drug Industry analysis the "molecular structures of medicines have become increasingly complex, and more difficult to formulate," therefore, given that the same amount of capital is spent on research and development, the productivity of that division continues to decline. The research is of the utmost importance for two reasons. First, should a drug get to the market and then realize unintentional side-affects, the pharmaceutical company is liable for damages. Second, should a drug that is seen as having a large amount of potential, but has not yet reached the market fail in its approval process, the consequences can be a drop in consumer confidence that is realized in a drop in the stock price (WSJ). Also, the Food and Drug Administration's (FDA) approval of Chinese drug imports, as well as, the promises of lower healthcare costs from Presidential candidates during this election year paint a grim picture for the U.S. pharmaceutical industry as a whole. On a positive note, due to outsourcing and the use of contract research organizations, the overall costs of pharmaceutical R&D have a savings rate of approximately 80%. Another "bright spot for industry demand" is the emerging market in China. This is especially favorable for Wyeth because, according to Value Line, over 46% of the Company's sales transactions are conducted internationally (Appendix A). This paper will analyze Wyeth Pharmaceutical's intrinsic stock value via the Discounted Dividend Model, as well as, industry analysis. II. Wyeth in the Current U.S. Economy Like many of the industries in the U.S., the pharmaceutical industry tends to follow the primary trend of the S&P 500, therefore, as the economy sits today, poised for a drop into recession, so does the pharmaceutical industry. However, the Federal Reserve Bank's Beige Book is slightly less dooming stating: "health-care services expanded in [3] Districts [?] Boston noted increased demand from the biopharmaceutical and aerospace industries" (Federal Reserve Beige Book). Figure 1 demonstrates the previous trend of Wyeth's stock price to fluctuate with the S&P index. Should this trend continue, Wyeth's stock price could find itself continuing to sink. Compared the industry, Wyeth's overall growth rate is much higher than average, as Figure 2 demonstrates. While Wyeth's growth rate also tends to follow the primary trend of the Dow Jones Industrial Average, the covariance between the two is much notable as Wyeth's ups and downs come in much larger jumps. Firms within the pharmaceutical industry have a few sector-specific problems to face. Lawsuits abound among drug companies, due to patent rights. This is one way for the brand name companies to keep generic products off of the market. If the formula for the generic drug too closely resembles that of the brand name drug, the brand name producer will file a lawsuit to have the generic drug removed from the market due to patent violations. Wyeth is currently involved in multiple lawsuits and appeals (www.wyeth.com/news). III. Five Forces Analysis Michael Porter's Five Forces Analysis (www.quickMBA.com) is a model that scrutinizes outside stimuli that exist within a competitive industry environment. This is used to look past the numbers in a security valuation in order to determine potential threats and opportunities of a firm. These factors include: rivalry between existing competitors, price of substitutes and complements, the power of buyers, the influence of suppliers, and barriers to entry into a industry. By analyzing the pharmaceutical industry, one is better able to grasp the situation of Wyeth in the Company's industry. Rivalry Between Existing Competitors According to the Google Finance, there are approximately eighty firms in the major drug manufacturing industry including such notable names as Pfizer, Johnson & Johnson, and Merck & Company (Finance.google). While these competitors are notable and a viable threat, there is an even more ominous gremlin on the horizon: Generic Pharmaceutical. Little known companies such as Barr Pharmaceutical, Catalyst Pharmaceutical, and Mylan Incorporated all have the ability to undercut "Big Pharma" by producing nearly-exact copies of big-name drugs and selling these replicas at a lower price without using commercials and brand names to attract customers. What matters most in the pharmaceutical industry whether brand name or generic is the timeline of initial development to market. Given the limited amount of time that patents last, the more quickly a company can get a drug past all the tests and onto the market the more time that drug will monopolize those who use it. The catch is that the development-to-market timeline can often take as much as fifteen years due to government regulations, testing, and FDA restrictions, thus reducing the time that the drug can retain sole custody of its users. The newest trend, according to Value Line, is the use of contract research organizations to accelerate the overall testing and approval process (Appendix B). Price of Substitutes and Compliments As mentioned in the above paragraph, generic drugs are one of the main determinants of the success of a certain drug. If a drug can be reverse-engineered quickly and a substitute produced within a short period of time, the initial drug will immediately begin to lose value. If a generic substitute comes at a cheaper price with the same result any recipient, assuming a rational human being, would choose to purchase said substitute, making generic drugs an extremely large potential threat. In this industry there are no notable complements, assuming an individual does not need multiple drugs for a single ailment; therefore, compliments are seen as neither a threat nor an opportunity. Power of Buyers In the pharmaceutical there is literally no power for the buyers. Because, in most circumstances, the buyer is in need of said product, the buyer has no room for negotiation. The only restrictions placed on the price of a drug come from government regulation and healthcare assistance. Bargaining Power of Suppliers The cost of raw inputs directly affects the price of a drug. For a drug that is new to the market and has no substitutes, this cost is transferred directly to the buyer. However, according to Value Line, the use of "China's low-cost structure (labor and the like) and abundant natural resources" allow U.S. based pharmaceutical companies to import lower priced inputs for their products (Appendix B). Individual research firms are in hot competition for competent and enthusiastic researchers to continue the R&D process. While this labor is not at a premium, firms must use enticing salaries to persuade top researchers to join the firm's team. Barriers to Entry In the pharmaceutical industry, the barriers to entry for a new firm are extremely high, thereby acting as an opportunity for Wyeth. The cost of proper research facilities is extremely high, as well as the cost of knowledgeable staff to manage said facilities. On top of initial costs, it is development-to-market wait. Until a drug is developed, tested, approved, put on the market, and sold no income is realized. As mentioned earlier, this process can?and usually does?take years to complete. With so many competitors and drugs already in the market, unless a significant advantage is realized there will be very few new entrants into the pharmaceutical industry. IV. Discounted Dividend Model In Appendix C a hybrid of the Price/Earning analysis and the Discounted Dividend Model is used to determine the future value of Wyeth's stock from the formula given in class. This formula takes the summation of the estimated dividends over the next four years divided by one plus the required return, as well as, the product of the P/E ratio and the Earnings Per Share divided by the same divisor (Appendix C). The required return is determined using the Capital Asset Pricing Model (CAPM), which adds the risk-free rate and the product of the market risk premium and the Beta coefficient. According to this formula, the value of Wyeth Pharmaceuticals on March 11, 2008 is $50.37 using a market risk premium of 5%, which is prices the security well above the present price of $40.65. However, this DDM was completed using data from January 18, 2008, and on that date the market price of Wyeth was $47.47, much closer to the price estimated here. Using a sensitivity analysis that focuses on the effect of the market risk premium the calculated intrinsic value fluctuates by approximately $6. Moreover using a market risk premium of 6.5%?as most firms would, given the looming possibility of economic recession?the intrinsic value comes out to $47.88, a mere $0.41 shy of Value Line's price. Also, today's beta for Wyeth, according to Finance.Google.com was 0.70, a full 25/100 lower than it was on January 18, 2008. V. Conclusion According to less-than-current data, Wyeth is currently undervalued by $10, a healthy margin and worth buying into. Also, Wyeth recently completed agreements to build a $280mm manufacturing facility in China to take advantage of the growing Chinese market (Wang). Given this and the Company's under-priced intrinsic value, Wyeth would be a decent investment. Works Cited Federal Reserve Bank. Current Economic Conditions. February 25, 2008. Finance.Google. http://finance.google.com/finance?catid=50631762&hl=en. Accessed March 12, 2008. Wang, Shirley. Wyeth Plant Will Tap China. The Wall Street Journal, Section D3. March 11, 2008. Wyeth-Progenics Drug Fails in Late-Stage Test. The Wall Street Journal (In Brief), Section A14. March 13, 2008.