British manufacturing retains few world contenders, but thanks to AstraZeneca and GlaxoSmithKline it still walks tall in the pharmaceuticals sector. Without the sector, our trade gap would be even worse in 2005, the UK pharmaceuticals industry's exports were valued at £12.1bn against £8.7bn for imports. However, both flagship carriers recently had bad news for investors, reflecting what the FT's Lex calls "the predicament of rising immediate earnings but fading long-term hopes". Astra cancelled further development of a stroke treatment after disappointing clinical trial results and GlaxoSmithKline revealed that progress on several major new drugs, including one for cervical cancer, had been set back.
As Graham Searjeant observes in The Times, the industry is one of "extraordinarily high risks as well as sometimes almost offensively high rewards", so setbacks must be anticipated. It can take a decade for a new drug to move from conception to market launch. Even when it reaches the clinical trials stage, there's an up to 90% chance it won't clear the final hurdle. What's more, the authorities are increasingly reluctant to authorise new treatments unless convinced that there is no risk of harmful effects on patients. Even if a drug does make it, its profitable lifespan is limited as cheaper, generic rivals will follow once patent protection is removed.
It's a tough environment, so it's no surprise that the sector's shares "can go out of fashion for long periods". The industry is still reinventing itself after the glory years of the 1990s, says Nils Pratley in The Guardian, who cites three reasons for today's leaner times. First, the science has become tougher most of the easier-to-find compounds have been discovered; second, governments are less willing to shell out for fancy new drugs; and third, generic competitors have resorted to hiring aggressive lawyers to challenge patents earlier. Companies have responded by merging and reducing their cost bases, cutting back both their marketing budgets and armies of salesmen.
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Having factored in these economies, investors are now focused on the new product pipeline and potential future blockbusters. Astra's earnings strength rests largely on five best sellers: Nexium (for stomach acid), Crestor (cholesterol), Arimidex (breast cancer), Symbicort (asthma) and Seroquel (schizoprehenia). Chief executive David Brennan wants to boost its portfolio of early-stage drugs and recently bought Cambridge Antibody Technology for £702m as part of this strategy. But Merrill Lynch reckons Astra needs to generate annual sales of $3bn from new drugs in 2010 to meet projections. GlaxoSmithKline's prospects have also been hurt by delays. Credit Suisse analyst Steve Plag tells The Sunday Times that he expects its "very substantial pipeline slippage" to cost the group £2bn in lost sales per year in five years, with sales growth set to dip from 4.1% to 2.5% by 2010.
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It's a more upbeat story at the UK's third-largest drugs group, Shire, which saw strong third-quarter figures after beefing up its US presence (see below). And investors will soon have a new pharma major to consider: Pharmstandard, Russia's largest drugs company by sales volume, plans to list in London. But those best placed to benefit from the sector's pipeline problems could be small stocks with promising drugs in late-stage trials. We look at three such companies below.
Investing in pharmas: the best four plays in the sector
Many analysts agree that, given the fragility of its product pipeline, Astra is overpriced while GlaxoSmithKline (GSK, £14) looks reasonable. But more promising than either is Shire Pharma (SHP, 940p), which has done well from its Adderall XR slow-release medicine to treat attention deficit hyperactivity disorder (ADHD). A 29% share of the US market puts the group ahead of local competitors, such as Eli Lilly and Johnson & Johnson. Half of Shire's sales are from ADHD products, but it is lessening this dependence. The £917m acquisition in 2005 of Transkaryotic Therapies, developer of a treatment for Hunter Syndrome, is part of its diversification strategy.
Alternatively, you could look at stocks likely to benefit from big pharma's need to find new products. Trials of Alizyme's (AZM: Aim, 102p) anti-obesity drug, Cetilistat, are at an advanced stage. Future sales are forecast at more than $1bn a year, but the group is still seeking a partner.
The resulting depressed share price makes it a potential takeover target. Another possibility is Plethora Solutions (PLE: Aim, 194.5p). Its Osbon ErecAid product has been approved for use in the US to help men recover from prostate surgery. It is also close to licensing a spray to combat premature ejaculation. Shares reckons it could attract bids from GlaxoSmithKline, Johnson & Johnson and Pfizer.
