When the market on Pharma stocks contradicts fundamentals

Hardly a day goes by without the stock prices of one or more Big Pharma companies reaching a 52-week high.  Of the nine Big Cap pharmas covered by Sanford Bernstein, they rate six as Outperform (i.e., Buy) and three as Market-Perform (amounting to Hold). 

Also this week Citigroup reported that in February, EU-based Big Cap pharmas outperformed the market by 5% while US-based Big Caps ran 6% ahead.  Smaller specialty pharmas, both here and in Europe, performed comparably ahead of other sectors.

At the same time that pharma's stock prices are soaring, the results show 2012 total sales for most Big Pharmas were down and actual sales for several 2012 launches, to this point, have totaled well below their estimates.  Some examples will make the point (see here):

  • GlaxoSmithKline's 2012 sales for prescription products were 1% below the previous year;
  • Novartis's 2012 sales were essentially flat, showing a 0% change from 2011 in constant currencies
  • Sanofi's pharma sales last year declined by 0,4% in constant currencies;
  • Merck sales in 2012 fell 1%, excluding foreign currency exchange values;
  • AstraZeneca ended 2012 with sales more than $5 billion below the previous year;
  • Bristol-Myers Squibb took a 17% hit to sales last year.

EP Vantage recently reported that several of last year's touted product launches have been disappointments compared to their initial projections.  (See here) They found that four of last year's top five biotech launches generated sales noticeably below their projections.

Another fundamental, pharma's R&D operation, also raises cause for concern.  Despite a flurry of approvals last year, trumpeted by both the industry's trade lobby and the FDA, only thirteen of the approved drugs, representing 35% of the total, were licensed to Big Pharma, a figure that appears consistent with a trend spanning the past eight years.  One writer, Bernard Munos, noted that historical data suggest only four or five out of those thirteen will each sell $1 billion or more. Such sales are insufficient to generate an adequate return on equity for Big Pharmas.  Also, those Big Pharmas with the greatest need for new product approvals -- AstraZeneca, Eli Lilly, and Abbott -- failed to get them last year.

And what are pharma's answers to these worrisome patterns?  Two in particular stand out.  One path favored by industry leaders consists of developing a product scheme heavily weighted toward specialty drugs.  With less price resistance to therapies for cancer, MS, Alzheimer's and other serious conditions, the industry believes it can greatly escalate per patient prices and, thereby, make more money from selling fewer pills.  This week the pharmacy benefit manager Prime Therapeutics forecast that by 2018, specialty products will account for 50% of all drug costs (see here).

Carried to the lengths desired by pharma's shortsighted managers, this heavy reliance on high-priced specialty drugs will produce a nasty backlash.  Right now pharmas avert the wrath of patients and other consumers by foregoing patient co-payments and settling for the +/-80% of the unconscionable price, the portion paid by insurers.  But insurers aren't imbeciles and their historically conditioned response to such circumstances is to raise premium rates.  Once that happens and millions of people again have to choose between paying for health insurance and paying for food or rent, consumer outrage will follow swiftly.  Pharma offers an inviting target for their scorn.

Pharma's other soothe-all remedy for underwhelming R&D and sluggish sales consists of the evergreen diversion about the emerging global markets,  The industry appears at least temporarily mum about promoting this growth prospect in light of India's Supreme Court decision this week to strip patent protection from Novartis's Glivec.  But the process of disrupting pharma's delusion of a big-rock-candy-mountain in the emerging markets is not limited to that single shot across the bow.  This week the Indian pharma Glenmark also launched a knockoff of Merck's diabetes blockbuster, Januvia, while another Indian drug maker, BDR Pharma, will likely receive a compulsory license (i.e., a patent-breaking decree from the government) to launch generics of Bristol-Myers Squibb's cancer drug Sprycel and Roche's Herceptin (see here). 

Patent breaking isn't the only means for emerging nations to thwart pharma's neo-imperialism.  India is also likely to develop a mandatory pricing scheme in which pharmas will be obliged to take the lowest price offered for a drug in Europe and adjust that downward according to India's lower per capita income (see here).  Then on April 2, Citigroup analyst Richard Yeh reported that China's State Council, NDRC, approved a guideline for drug distribution reform aimed at building a pricing mechanism and establishing a monitoring system for ex-factory drug prices.  

Manufacturers must provide the Chinese Ministry with accurate ex-factory prices.  Those that refuse to do so, and others that sell drugs with a large gap between ex-factory and retail prices, will be declared ineligible to submit tenders (bids) to the various purchasing entities.  Yeh reports that the policy could hit the profitability of manufacturers producing drugs in low-cost countries (resulting in low ex-factory prices) that turn around and submit high tender prices.

Last month Bloomberg reported that China will make drug manufacturers compete for formulary positions through a negative auction.  In the interests of poetic justice, they should make Novartis's Joe Jiminez wield the auctioneer's gavel.

So what is one to make of it when stock market prices lose all rational connection to fundamentals.  In part, the answer lies in the old stock trader's axiom that a good stock and a good company can be two, entirely different things. 

Right now money is pouring into drug stocks, driving up their share prices, because some of them, such as Merck and AstraZeneca, are paying ~6% dividends.  In a 1.5% environment, there are few available places where investors can park money to produce such a return.  That's fine as long as the federal reserve and the larger economy keep interest rates at current levels.  But when they rise, as they inevitably will, those dividends won't offer much advantage.

The lifeblood of stock analysts consists of creating churn.  No commissions are generated from hold recommendations.  So the analysts, ever working their own agenda, talk up buys one quarter and sells the next.  All the while, pharma's fundamentals continue on their own, dreary course.

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