Wall Street Eyes Pharmaceuticals as Election Day Nears

As the presidential election draws near, many on Wall Street (search) are growing nervous about the potential effect of Democratic candidate John Kerry's (search) platform on prescriptions drugs, and how it might reduce the earnings of the companies that produce them. But some analysts say curbing drug prices is bound to become a larger issue in the years ahead, no matter who controls the White House.

Kerry's plan includes a number of proposals to cut the cost of prescription drugs, including allowing the reimportation of medicine from outside the United States, changing the Medicare (search) law to allow the government to negotiate drug prices directly, and lowering certain barriers to generic drug competition. The changes would almost certainly lead to lower earnings for pharmaceutical companies, and some argue they would ultimately stifle innovation within the industry.

As a result, drug stocks have come under pressure; the pharmaceutical HOLDRS, a type of exchange-traded fund that tracks the value of about 20 drug stocks, has dipped 5.2 percent this year. Though President Bush's lead over Kerry in polls is widening with just seven weeks left before the election, analysts say drug company share prices could falter even more if Kerry shows signs of narrowing the gap.

Wall Street has placed a great deal of emphasis on the potential regulatory changes under a Kerry administration, but a second Bush term wouldn't necessarily be a home run for drug stocks, either. Analysts say big changes are coming to the industry regardless, especially following the passage of the Medicare drug benefit last year, which guarantees cheaper drugs for all senior citizens once it takes full effect in 2006.

At issue is how much latitude the government will have to negotiate the cost of drugs. The Medicare law forbids the government from negotiating price discounts with drug makers. But if Congress reversed itself on that point, Medicare would carry a big stick: It would have direct purchasing power over 50 percent of the market.

"If Kerry were to win, and do what the drug companies are afraid he'll do — authorize the secretary of Health and Human Services to negotiate prices — I think that would be a fairly constant pressure on the industry, and would change the nature of that investment forever," said Richard Evans, pharmaceuticals analyst at Bernstein & Co. "I'm not wholly convinced Bush wouldn't do it, but I think the degree of certainty with which that happens and the speed with which it comes about is certainly higher with Kerry."

With the number of people who want to take advantage of the drug benefit steadily rising, analysts say the expense of paying for all of those prescriptions will grow increasingly onerous unless steps are taken to control prices. Because the measure is popular among voters, even Republicans in Congress may soon start looking more seriously at directly negotiating costs. Bush also might be more inclined to take bolder steps in his second term, as a way to build his legacy with little political cost.

"Ultimately it doesn't really matter who's in office," said Paul Heldman, managing director for healthcare at Soundview Capital Markets, Schwab's Washington research group. "Government entitlement programs always wind up costing more than people anticipate. And you also have the fact that the Medicare program is going to grow ... the number of people it serves will grow pretty sharply as the baby boomers retire."

It makes for a confusing landscape for small investors, but there are still some opportunities out there. For large pharmaceutical companies, having a robust pipeline of new drugs will matter a great deal more in the years ahead, because those firms will be able to command a better price for their products from the start. Among U.S. drug makers, Eli Lilly and Co. has the strongest pipeline of new drugs under development over the immediate term, Evans said, and over the intermediate term, GlaxoSmithKline PLC and Bristol-Myers Squibb Co. have decent prospects.

There also may be opportunities ahead for makers of generic drugs. Some believe they will be more widely prescribed once senior citizens start getting their drugs through Medicare. There's also a chance that barriers on generics for certain classes of drugs will be eased through legislation.

Despite all the stumbling blocks ahead many investors remain upbeat about the prospects of drug stocks. Some analysts believe any election-related impact will be short-lived, and that the free-market system will work out a compromise to keep drugs affordable while still allowing the pharmaceutical companies to generate a profit for investors.

"There might be a bit of a scare at first, but it's still a major growth area for the world and the global economy. Biotech is the future. I think any weakness would be a buying opportunity, with caution, of course," said Jeffrey Hirsch, editor of the Stock Trader's Almanac and the Almanac Investor newsletter. "The market itself is probably in for some tough sledding for the next couple of years ... after this bull run and the first two years of the president's term. But I wouldn't think this could possibly mean the end of this industry. Any reaction would probably be an overreaction."