Investing in pharmaceutical companies? The pipeline is key

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published 13 November 2024

Current profits are not necessarily the best guide to selecting pharmaceutical companies for investment. This is because earnings may reflect strong but temporary sales of blockbuster drugs that are unlikely to continue, either because the drugs are about to come off patent or because of a short peak in demand for drugs treating a temporary condition, such as an epidemic. In these and other cases, the strength of a company’s pipeline is more important than its recent profitability because the late-stage pipeline determines future sales and profits.

For example, if a company’s last set of results depended heavily on sales of a blockbuster drug that is about to come off patent, future profitability will suffer as generic drugs enter the market following the expiry of the patent, unless there are comparably profitable drugs emerging from the late-stage pipeline. Drug giants Pfizer and AbbVie illustrate these two points.

Pfizer
Our first example is Pfizer, which benefited from massive but temporary sales of its Covid vaccine developed with BioNTech of Germany. This pushed its sales up from $41.7bn in 2020 to $81.3bn in 2021 and $100.3bn in 2022. But sales then fell back sharply in 2023, to $58.5bn. The share price followed this pattern, soaring from $27.50 in March 2020 to $59.50 in December 2021, but then falling to a low of $25.30 in April 2024.

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AbbVie
A second example is AbbVie’s Humira for rheumatoid arthritis and similar immunological diseases. It was the world’s best-selling drug in 2022, with peak sales of $20.2bn – the first drug ever with annual sales over $20bn. Humira’s US patents expired in early 2023 and generics were launched. As a result sales in 2023 fell to $14.4bn and then to $5.1bn in the first half of 2024.

However, AbbVie had new patented drugs in its pipeline, including Skyrizi and Rinvoq, developed to treat similar immunological conditions to those targeted by Humira. This limited the damage to sales and the share price. AbbVie’s stock only fell from $162 in November 2022 to $135 in June 2023, but it had eclipsed $200 by October 2024. These and other examples show how important it is to examine a biopharma firm’s pipeline – particularly its late-stage pipeline – before deciding to invest.

A biopharma’s late-stage pipeline is most important since the probability of a new drug failing in clinical trials is much lower for the final stage-III trials. There is a 49% probability that a drug starting its stage-III clinical trial will get regulatory approval. The success rate is only 15% for a drug starting its stage II trial and only 10% for a drug starting its stage-I trial.

The recent interest in weight-loss drugs exemplifies the importance of late-stage pipelines. Financial research and investment platform Morningstar now estimates the market size for weight-loss drugs at $200bn by 2031, up from only $6bn in 2023. Weight-loss drugs therefore address a fast-growing and massive market. The scale of this market is emphasised by the most recent US national statistics, showing that 10% of Americans are severely obese and another 32% obese.

Novo’s share price has tripled since June 2021 when Wegovy was approved for weight loss. However, stage III clinical trial results on Wegovy were released in May 2020 showing substantial weight reduction and Novo’s share price is up three-and-a-half times since then. Lilly’s recent share price is up over 43% from November 2023 when Zepbound was approved for weight loss. However, stage-III results showing substantial weight loss using Zepbound were released in July 2023 and Lilly’s share price is up 83% since then. So investors who noted the late-stage clinical trial results did better than those waiting for FDA approval.

The other key point about Novo and Lilly’s GLP-1 drugs is that recent clinical trials show that they have beneficial effects on other conditions as well as diabetes and obesity. Recent studies suggest GLP-1s reduce cravings for heroin and alcohol, and a May 2024 study showed that Ozempic reduces the risk of heart attacks and strokes regardless of whether patients lose weight. In March 2024 the FDA approved Wegovy for the reduction of cardiovascular risk in overweight or obese adults with established cardiovascular disease. And Novo is testing semaglutide for early stage Alzheimer’s.

These additional benefits of weight-loss drugs are likely to increase the size of the market. Both Novo and Lilly have two more obesity drugs in stage III trials and three in stage II trials. Both oral and injectable versions are under study and one each of the Novo and Lilly stage-II trials are of GLP-1/GIP drugs. Interestingly, Novo announced in March 2024 that a small stage-I trial of a new drug, Amycretin, showed a 13.1% weight reduction after 12 weeks compared with a 6% weight loss for Wegovy over the same period.

AstraZeneca
AstraZeneca has a strong pipeline of cancer drugs, which is why Pfizer bid for the company in 2014 but withdrew its offer after AstraZeneca’s board rejected it. Pfizer bid £55 a share in Pfizer shares and cash, but AstraZeneca’s shares were over £120 for most of May to September 2024. AstraZeneca has a particular focus on lung cancer, which accounts for a fifth of all cancers. The lung cancer drug market was worth $30bn in 2023 and is expected to more than double by 2032.

Merck has 16 drugs in stage III and 17 in stage II. Of the 33, 10 are for lung cancer. J&J’s pipeline of oncology drugs has 20 drugs in stage III (15 for blood cancers, but none for lung cancer) and two in stage II. Bristol has nine in stage III and five in stage II; six of the total of 14 are for lung cancer. AstraZeneca’s oncology pipeline has 25 stage-III clinical trials with another 13 in stage II and 18 in stage I; 11 of the total of 38 are for lung cancer and nine for breast cancer.

Alzheimer’s disease accounts for most cases of dementia. There were 55 million cases of dementia worldwide in 2020, but the figure is expected to rise to 78 million by 2030 and 139 million by 2050. New drugs have been approved over the last year or so which, while they do not cure the disease, do markedly slow cognitive decline and therefore give patients more years of useful life. The leading treatments are Lecanemab (Leqembi) from Biogen/Eisai and Donanemab from Lilly, which were approved by the FDA in 2023 and 2024 respectively.

The advent of these and other new drugs yet to be named is expected to drive the market for Alzheimer’s treatments from $2.2bn in 2020 to $22bn in 2030. Biogen has another Alzheimer’s drug in stage-II trials and further stage-III trials of Lecanemab. Lilly has two Alzheimer’s drugs in stage II, one in stage III as well as a further stage III trial of Donanemab. AbbVie has three Alzheimer’s drugs in stage II and is buying Aliada Therapeutics for its promising stage-I Alzheimer’s drug.

The first is that the company should have substantial sales in large and growing markets.
Secondly, it should ideally have one of the leading drugs in one, or preferably two, of these markets.
Thirdly, the company should display substantial investment in research and development (R&D) and a well-stocked pipeline in growing therapeutic areas where it already has a substantial market presence and preferably those where it has a leading drug by sales.

The third example is AstraZeneca, which has successful oncology drugs on the market (two in the global top ten) and a pipeline strong in new drugs, particularly for lung and breast cancer, two of the most common cancers. AstraZeneca also has drugs for cardiovascular, respiratory diseases and immunology, together with a rare-diseases portfolio, a therapeutic area it entered with its acquisition of Alexion for $39bn in December 2020.

The fourth example is AbbVie, which for years dominated the market for immunology treatments (especially for rheumatoid arthritis) with the world’s best-selling drug, Humira. Immunology is still its best-selling area, accounting for half of sales. Its new immunology drugs – Skyrizi and Rinvoq – now notch up joint sales exceeding those of Humira, which from 2023 became subject to generic competition. AbbVie also has substantial sales in oncology, neuroscience and aesthetics.

The fifth example is Merck, whose Keytruda has been approved for several different types of cancer and is the world’s top-selling oncology drug. Keytruda currently accounts for about 45% of sales, with vaccines being the other large area. However, Keytruda’s key patent expires in 2028, so replacing it with new drugs from Merck’s pipeline is a top priority. Merck’s pipeline is dominated by new oncology drugs but also includes drugs for cardiovascular diseases, antiviral (HIV) illnesses, and new vaccines.

AstraZeneca’s revenue is up 72% from 2020 to 2023, with operating profit up 123% over the same period. The forward p/e is 15.6 and the forward yield is 2.1%. The share price is up 7.8% over the past 12 months. AbbVie’s revenue rose 18.6% from 2020 to 2023, with operating profit up 6.3% over the same period. The forward p/e is 16.8 and the forward yield is 3.3%. The share price is up 42.7% over the past 12 months.

Merck’s revenue rose 45% from 2020 to 2023. Operating profit was up 230% from 2020 to $18.3bn in 2022, but then fell to $3bn in 2023 because of increased R&D expense, which rose from $13.5bn in 2022 to $30.5bn in 2023 for three reasons: a collaboration agreement with Daiichi Sankyo; two acquisitions; and increased expenditure on clinical trials of new pipeline drugs. The forward p/e is 10.5 and the forward yield is 2.94%. The share price is up only 2.1% over the past year.

Lower risk
The two lower-risk firms are AstraZeneca (LSE: AZN) and Novo Nordisk (Copenhagen: NOVO-B). AstraZeneca is growing strongly, has a reasonable forward p/e of 15.6, a dividend yield of 2.1% and is strong in cancer, particularly in treatments for major cancers such as those of the breast and lung. Current drugs are backed up by a strong pipeline. Novo is also growing strongly; boasts a prime position in diabetes and obesity; and has a strong pipeline in both these areas, as well as in cardiovascular and liver diseases. But it has a higher p/e of 28 and a lower yield of 1.28%.

Reasonable risk/reward
Eli Lilly (NYSE: LLY) is also growing strongly and has demonstrated the ability to be the second company to bring out new drugs in new key areas, such as obesity and Alzheimer’s, in addition to its presence in several established disease areas (diabetes, cardiovascular, immunology, neuroscience and cancer). However, it is riskier than Novo or AstraZeneca since its forward p/e is a high 37.5 and the yield is only 0.61%.

Highly qualified (BSc PhD CPhys FInstP MIoD) expert in R&D management, business improvement and investment analysis, Dr Mike Tubbs worked for decades on the 'inside' of corporate giants such as Xerox, Battelle and Lucas. Working in the research and development departments, he learnt what became the key to his investing; knowledge which gave him a unique perspective on the stock markets.

Dr Tubbs went on to create the R&D Scorecard which was presented annually to the Department of Trade & Industry and the European Commission. It was a guide for European businesses on how to improve prospects using correctly applied research and development. He has been a contributor to MoneyWeek for many years, with a particular focus on R&D-driven growth companies.