The biggest reason to be happy in 2013

Bosses of Britain’s pharmaceutical companies may need to take a few of their own stress-busting pills. Tensions have been boiling over. According to media reports bosses of big pharma companies have been “lashing out” at the NHS and “venting their fury” at the rejection of potentially life-saving new drugs by the National Institute for Clinical Excellence (NICE). The Association of the British Pharmaceutical industry called a crisis meeting over this “huge concern”.

With cash-strapped European health authorities putting the squeeze on drug suppliers, the industry is facing a “patent cliff” as its best selling drugs run into competition from low-cost generics, and the lack of blockbuster drugs emerging from the multi-billion dollar research programmes, the outlook for the sector looks pretty grim.
Or does it?

A note from the healthcare team at Edison Investment Research paints a much more optimistic picture. Let’s deal with the patent cliff first.

The industry could lose around $33bn

When drugs lose their patent protection, customers can finally buy low-cost generic competitors and the results can be brutal. Take Singulair, an asthma drug produced by Merck that had annual sales of $4.6bn. As soon as it went off patent, its’ sales tumbled by 87%. This year the industry could lose around $33bn of sales to patent expirations, a huge hole to fill.

But this is not news. It will come as no surprise and must surely now be discounted in the share prices of a sector that is comprehensively covered by analysts. Furthermore, 2012 is expected to be the worst year for patent expirations. Once the industry has fallen over the cliff it cannot fall over it again.

The turn of the calendar year marks the point where analysts start to extend their projections out by an extra 12 months and as Edison points out, “as they rebase their five year Compound Annual Growth Rates at the start of 2013, earnings forecasts will look a lot more encouraging”.

The popular perception is of a lack of new blockbusters but again this is not quite borne out by reality. 2012 has in fact been a bumper year for new drug approvals, especially in the United States where over 30 new drugs include potential blockbusters such as Kalydeco, a cystic fibrosis treatment from Vertex Pharmaceuticals, Medivation’s Xtandi for prostate cancer, and Pfizer’s Xeljanz for rheumatoid arthritis.

These are selling well and commanding high prices. While prices of generic medications in the USA are falling fast, the latest data for the third quarter reveals a 13.3% increase in the price of branded drugs in the USA.

Governments looking to cut costs

With the re-election of President Obama there are unlikely to be major changes to the US healthcare regime in the near term, but while the coast is clear on that side of the Atlantic, the situation is far tougher in Europe. The pharmaceutical industry is an easy target for governments desperate to cut costs. Many countries in southern Europe have simply not paid their bills.

Earlier this year it was reported that Greece, Spain, Portugal and Italy owed $20bn to the big drug companies. Elsewhere health authorities are getting tougher. Germany and France are both targeting big cuts in health spending and since hospital patients cannot be turfed out onto the streets, the drug companies are bearing the brunt.

Prices are under pressure, while the criteria for approving new drugs are getting tougher. NICE now seems to put a value of £30,000 on each additional year of life. If a drug can deliver that amount of benefit, it will pay up to £30,000. Otherwise it will not.

Although I may not say the same when I reach old age, this harsh approach that acknowledges the cost to all tax-payers of the prolongation of life for a few is surely the right way to go and the drug industry needs to factor this into its research programmes.

New avenues of medical research opened

Fortunately, the new age of biotechnology is opening up new avenues of medical research which are being met with enthusiasm in the USA at least. Over there investors are keenly interested. The NASDAQ Biotechnology Index is up around 30% this year, 12 new companies have made their debuts on NASDAQ and investors have committed $4.8bn in follow up equity funding to quoted companies – figures in stark contrast to the indifference shown by European investors.

As ever in this area, drug approvals are as crucial to investor returns as they are unpredictable, and this can make some companies high risk. But this is nothing new. Overall Edison is optimistic for the sector as we go into 2013. “We remain hopeful that current sentiment is maintained”, it says, “and that investors reinvest their winnings. This should ultimately be of benefit to both US and European companies.”

I think Biotechnology is the biggest story of our time. In fact, I just shot a video with the folks at MoneyWeek where I explained why I think this biotech boom bears comparison with the early days of the dotcom boom in the nineties.

This is one sector where I believe there are huge profits in prospect for 2013. And that’s why I’m delighted that so many of you joined me on the Red Hot Biotech Alert this year.

• This article is taken from Tom Bulford’s free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.

Information in Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Penny Sleuth is an unregulated product published by Fleet Street Publications Ltd.

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