(JNJ) Bayer Cut to Underperform

We recently downgraded Bayer (BAYRY) to Underperform from Neutral purely on valuation grounds. We believe that the stock is overvalued at current levels.

Even though the US Food and Drug Administration (FDA) cleared Bayer/ Johnson & Johnson’s (JNJ) potential blockbuster blood thinner Xarelto for stroke prevention in atrial fibrillation (SPAF) earlier in the month, the associated warning that discontinuation of the drug increases the risk of stroke in SPAF patients could hamper its sales. Below-par showing by Xarelto could pull down the stock significantly. Moreover, the presence of Boehringer Ingelheim’s Pradaxa (approved by the FDA in 2010) has intensified competition in the market.

Moreover, Bayer delivered average results in the third quarter of 2011 with key drugs such as Betaferon, Kogenate and Levitra not performing well. Sales in the Pharmaceutical segment were flat due to weakness in the North American and Western European markets because of healthcare reforms in those territories. Continued weak performance in the key markets could also pull down the stock. Moreover, the limited near-term catalysts at Bayer also concern us. We have reduced our 2011 and 2012 earnings estimates by $0.16 and $0.46 per ADS, respectively.

Furthermore, Bayer, which operates through three major segments- Healthcare, Material Science and Crop Science – has been looking to strengthen its HealthCare segment. The company has been inking deals/making acquisitions to achieve the objective. For example, in September 2011, Bayer purchased Kirkland, Washington based Pathway Medical Technologies, Inc. to strengthen its HealthCare segment. Moreover, in early 2011 Bayer inked a deal with Zydus Cadila to strengthen its pharmaceutical operations in one of the most sought after markets – India. However, if these initiatives fail to deliver the desired results due to integration risks associated with mergers, then it will weigh heavily on the stock.

These negative factors cause us to believe that the stock is overvalued and there is little reason for investors to own the stock at current levels.

BAYER A G -ADR (BAYRY): Free Stock Analysis Report

JOHNSON & JOHNS (JNJ): Free Stock Analysis Report

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