There’s Promise in Merck Pipeline, Growth at a Price in Xilinx
Stock Exchange lets readers listen in as Times staff writers James Peltz and Michael Hiltzik debate merits of individual stocks.
Merck (MRK)
(Jim: Buy)
(Mike: Buy)
* Jim: If you want to know why the Dow Jones industrial average is drooping these days, a good place to start is with Merck, right, Michael?
Mike: Yes. The stock’s been trading near a two-year low.
Jim: Merck is the nation’s biggest drug maker, but there are a couple of notable aspects to this company--both of which I think account for why investors have given the stock a cold shoulder. First, Merck has several strong drugs.
Mike: Strong in the sense of being potent, or in the sense of bringing in the moolah?
Jim: Both. But I’m mainly referring to the gobs of money they make for Merck. Trouble is, though, these drugs are going to lose their patent protection over the next two years, and that’s bad news.
Mike: Let’s name a couple of them.
Jim: OK, one is Vasotec, which treats hypertension and does more than $2 billion a year in sales.
Mike: Then there is Zocor, an anti-cholesterol drug for all of you meat-eaters out there. And speaking of eating, another one is Pepcid, which is used for treating heartburn.
Jim: The problem is when Merck loses its patent protection, that opens the door for generic drug makers to start rolling out their me-too versions--which sell for much less than Merck’s drugs.
Mike: Basically, the market gets pretty crowded.
Jim: Right, and Merck’s sales of those drugs start dropping in a hurry.
Mike: So the question on everyone’s mind is, what will Merck do for an encore?
Jim: That brings up my second main issue with Merck. While the rest of the drug industry has been doing gargantuan mergers like there’s no tomorrow, a la Pfizer and Warner-Lambert, Merck has stoutly refused to marry one of its rivals.
Mike: Good point. They’re all merging in large part because their patents are also running out and they need to fill their pipeline with new drugs. In other words, sometimes it’s easier to buy drugs on Wall Street than to develop them in your own research-and-development labs.
Jim: Merck’s response to all this is not to worry, it’s got a pipeline full of promising new products that will take up the slack. And it’s true, Merck is renowned for its R&D.;
Mike: And already we’re seeing some of its new drugs take off. One is Vioxx, an arthritis drug that debuted with some very impressive numbers last year, even though it’s up against Monsanto’s big seller Celebrex. You’ll be glad to know, Jim, that Vioxx is in complete compliance with the drug companies’ orthography, which is to make complete nonsense out of a brand name. Wouldn’t it have been easier to just spell Vioxx with one “x”?
Jim: Let’s just be glad they didn’t use three “x’s,” but maybe they didn’t want to be mistaken for a porno operation. Anyway, having said all of this, I would buy Merck.
Mike: Would you have bought it at $80, or would you buy it now because it’s so much cheaper?
Jim: In good part because it’s so much cheaper. Look, I don’t discount for a moment the threat to Merck of losing its patent protection for some of its big sellers. But Merck didn’t get to this point by having gaping holes in its R&D; pipeline, and I see its new products helping Merck maintain its growth. And at this price Merck is a great buy.
Mike: Guess what? I agree with you.
Jim: Consider what we have here: One of the top pharmaceutical companies in the world trading at just 20 times its expected per-share earnings for 2000. Plus, I’m paid to wait a bit for the price to rise because Merck has a decent 2% dividend yield.
Mike: You’re right. This stock is a core holding for anybody who wants to be in the pharmaceuticals sector, and there are plenty of good reasons to be there. Yes, it’s been bumping along a trough lately, setting new 52-week lows almost every week. But sentiment toward Merck and the drug companies overall is going to turn around, so this is a great time to get in.
Jim: And even if it hasn’t turned around yet, I like what I saw in Merck’s fourth-quarter results, which were announced in January. Specifically, Merck noted that Vioxx sales helped lift its quarterly profit 12% from a year earlier. That bodes well for its upcoming quarterly results.
Mike: Yes, but it didn’t do much for Merck’s stock price.
Jim: I know Wall Street will need more than one quarter to get its hooks back into Merck. But that quarter was a good start, an early preview that Merck is still a strong company with a cheap stock that’s a screaming buy. And the rebound is already starting: Merck jumped from $53 to more than $60 last week alone.
Xilinx (XLNX)
(Jim: Buy)
(Mike: Buy)
* Jim: This stock showed up on my radar screen because a friend of mine works for Xilinx in Orange County, Mike. But, of course, that won’t affect my objectivity in reviewing this stock.
Mike: I should hope not. Now, Xilinx sounds like some character out of the X-Men comic books, but it’s actually a chip maker that’s on fire.
Jim: Right. Based in San Jose, Xilinx makes semiconductors that, in plain English, are programmable, so you can change their function after they’ve been installed. In other words, you don’t have to replace the chip; you just reprogram what you want Xilinx’s chip to do.
Mike: This is emblematic of the march of technology in computers. It’s always more efficient to rewrite software than to replace hardware, which is why the evolution of the computer has often been driven by the conversion of hard-wired circuits into software programs. And Xilinx has been a leader in the technology of producing these integrated circuits that can be given different functions.
Jim: And they’re really in demand these days. Xilinx counts among its customers such rapidly growing tech leaders as networking giant Cisco Systems and the telecommunications-equipment maker Nortel Networks, to name just two.
Mike: Xilinx also develops design software for other makers of integrated circuits, and that’s a very good business, as we discussed several months ago when we reviewed Cadence Design Systems.
Jim: It’s easy to see the attraction. Xilinx gives the tech-equipment makers the ability to keep tweaking their gear without having to tear everything down and install new chips.
Mike: That being said, there is an issue with the behavior of stocks like Xilinx. Get this: About a month ago, Xilinx traded for $57, and some Wall Street analysts estimated that the stock would hit $70 within the next 12 months. How about in the next 12 days! The stock already trades in the high $70s.
Jim: Not only that, but if you go back five years, you’ll see that for much of that time Xilinx’s stock just treaded water--until last summer, when it took off. That’s in good part because Xilinx started rolling out new products well ahead of the competition, and because it was geared toward wireless communications.
Mike: And we all know that wireless is the flavor of the year.
Jim: Exactly. The whole sector of wireless phones, satellites and other communications has just exploded. There’s Xilinx sitting in the catbird’s seat.
Mike: The result is that this stock has quadrupled in price in just the last 12 months, giving it a price-to-earnings multiple of, gulp, over 100 on this year’s results.
Jim: So would you buy it now?
Mike: You know, I’ve been beaten up enough over the last year or so by betting against stocks like this that are in midflight but still have a decent business with strong growth prospects. So I’d say Xilinx is still a buy.
Jim: You took the words out of my mouth.
Mike: Gee, the two of us must be on Prozac this week. We love everything.
Jim: Believe me, I have real problems buying a stock with a P/E of over 100, as our readers know well. But in this case I’d argue for paying that kind of premium because I believe Xilinx will deliver the superlative growth to justify the price--at least for the next 12 months. After that, I’d take another long look at this stock to see whether I’d keep it.
Mike: In fact, some of their leading products are still in “mid-ramp” as they say, which means they’re still growing rapidly.
Jim: There’s also lots of enthusiasm for some new wireless chips Xilinx has planned that have a copper base, which somehow makes them even more attractive for interconnecting wireless equipment. Don’t ask me to explain the technology further, except to say that these products, too, are supposedly ahead of the competition.
Mike: No question, I’d buy Xilinx, too. Know what, Jim? Too bad there weren’t any other stocks that could get in on this chat, because we’re buying everything today.
A Final Note
Jim: A reader caught a mistake we made in our review of Lockheed Martin last week, Mike, namely that we said the company was competing to build a next-generation fighter jet called the F-22. In fact, Lockheed Martin already builds the F-22 and the competition is for another future jet called the Joint Strike Fighter.
*
Write or e-mail with a stock you would like to see discussed in this column. Peltz (james.peltz@latimes.com) covers the markets and corporate financial trends. Hiltzik (michael.hiltzik@latimes.com) covers technology and entertainment and is the author of the book “Dealers of Lightning: Xerox PARC and the Dawn of the Computer Age” (HarperBusiness). Either can also be reached at Business Section, Times Mirror Square, Los Angeles, CA 90053.
*
You can hear a preview of Peltz and Hiltzik’s weekly column Mondays on the KFWB-Los Angeles Times Noon Business Hour on KFWB-AM (980).
