2012 was a poor year for Big Pharma.
In a market that made surprisingly decent returns, given the jitters in the global economy, the shares of drug makers were among the weakest performers (after you ignore the miners).
That’s partly because of concerns over cuts in healthcare spending in developed countries. It’s also because many investors were far more interested in the ‘sexy’ end of the healthcare market – biotech stocks.
On top of that, Big Pharma has been a perennial underperformer. Investors may just have grown bored waiting for it to come good.
Yet many of the biggest problems facing Big Pharma are quietly slipping into the past. Investors might want to give the sector another look in 2013 – indeed, the outlook could be brighter than it has been for years…
Drug makers have already gone over the ‘patent cliff’
Big drug makers have faced lots of big problems over the past decade.
There’s the ‘patent cliff’. That’s when branded drugs lose their patent protection. This means generic rivals can compete. Generics are far cheaper, so as soon as a drug goes off-patent, revenues are almost guaranteed to collapse.
There’s the fact that fewer new drugs have been getting through the regulatory process. In terms of drug treatments, all the ‘low-hanging fruit’ has been picked, was a common refrain of pharma executives in recent years.
And there’s the threat of slowing spending growth in developed countries, desperate to get to grips with soaring healthcare costs.
Looking at those factors, you can see why lots of people might want to dismiss Big Pharma companies as ‘dinosaurs’ – extinction seems to be only a matter of time.
Yet what the market seems to have missed is this: for most of these factors, the worst is already behind the industry.
As the FT’s Lex column points out this morning, the patent cliff is no longer the huge threat it once was. European pharmaceutical companies, according to Deutsche Bank, have a launch pipeline over the next two years that could potentially generate $64bn in peak sales. “That will easily outweigh the £27bn of patent expiry revenue losses those companies face in that period.”
So what about those tough regulators? Well, you might be surprised to learn that last year, the US Food and Drug Administration (FDA) approved 39 new drugs. Both 2011 and 2012 saw the highest levels of drug approvals in the US since at least 2004. So concerns that we’ve run out of new treatments that can make it to the market also seem to have been somewhat exaggerated.
Emerging markets want better drugs
Another worry is that governments in developed countries will make more effort to control spending on drugs in coming years as they try to tackle huge healthcare costs. That makes sense.
As populations age, and demands grow on public healthcare systems, we can expect broke governments to either become stingier about what they’ll pay for, or to improve their negotiating skills with drug suppliers. Actual spending is unlikely to fall – government spending rarely drops in absolute terms – but the rate of growth will probably drop off.
Europe is a problem in particular. With ‘peripheral’ countries such as Spain and Greece running out of money – there are reports of pharmacies actually running out of basic drugs in certain areas – the squeeze is definitely on.
However, one major factor should offset this: growing demand from wealthier emerging market consumers. As the middle class in emerging markets continues to grow, so will demand for more reliable and effective medicines.
As Ben Shepherd points out on InvestingDaily.com, global drug spending is expected to grow from around $956bn in 2011, to around $1.2 trillion by 2016. By that point, emerging markets will account for around a third of all drug sales, from about a fifth now.
What to buy
Clearly, biotech is the most exciting area in the healthcare sector. And unlike Big Pharma, it had a good year in 2012. My colleague Matthew Partridge covered a number of ways to invest in biotech just before Christmas.
Now, I rather like biotech as an investment myself, and I think that any long-term investor should have at least some money in the sector. But I wouldn’t neglect Big Pharma.
For all that its performance has been dull, big drug makers still throw off cash and pay attractive dividends, and it’s hard to see any of them going bust. Of all the ‘defensive’ sectors, this is the one I’m most interested in, mainly because it strikes me as the one with the best potential for growth in the long run. GlaxoSmithKline (LSE: GSK) – which I hold – is currently near a 52-week low and yields around 5.3%. It’s our preferred London-listed play over AstraZeneca.
If you’re prepared to go further afield, Danish pharma stock Novo Nordisk has had a superb performance over the past year – far better than Glaxo’s. Yet my colleague, Dr Mike Tubbs, reckons it has a lot further to go. You can find out why in his Research Investments newsletter. Learn more about Research Investments here.
• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .
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