Pharmaceutical sector encounters stutter

Have you checked the state of your medicine cabinet lately? If it’s typical of many US medicine chests, you might well have trouble closing it. According to the Center for Disease Control and Prevention, more than half of all Americans use at least one prescription drug, and almost 20 percent are on some sort of medication. Although these statistics hardly flatter the health of US citizens, it’s been terrific news for the coffers of big pharmaceutical companies – until recently.

Despite massive R&D investment, several big pharma names have lately fallen sick due to a lack of new products, not to mention a spate of products being whipped off the shelves because of health fears. US drug company Merck withdrew its anti-inflammatory drug Vioxx after allegations it could double heart attack and stroke risk. Bextra, an anti-arthritis drug from Pfizer, had similar allegations made against it. In the UK drug company AstraZeneca has seen its share price dive almost 30 percent in the last year, partly due to side effect worries over its blood-thinning drug Exanta and disappointing results from its lung cancer drug Iressa, which shrank tumors but did not prolong patient life.

Ryan Hughes, an investment manager at UK-based Chartwell Investment Management, says much of the recent difficulty is because the drugs that swirled around in the 1980s and 1990s – such as sex-related Viagra and Levitra, depression-lifter Prozac and cholesterol-beater Lipitor – were so successful that follow-ups are simply proving a mission too far. ‘We’ve had these massive amounts of drugs but you can’t continue to produce these type of drugs continuously,‘ he explains. ‘You have to invest the profits into research, and sometimes things simply don’t come off; it becomes dead money. That’s why many fund managers are now thinking laterally, looking at companies producing medical devices such as advanced prosthetic limbs, or private medical care, for example. The fundamentals may not be great, but there are opportunities.’

Graham Parry, head of pharmaceutical research at Merrill Lynch, agrees there are opportunities, particularly in Europe. His team recently released a pan-Europe pharma sector review report and Parry has subsequently gone overweight on the sector. ‘Relative valuations have retrenched to attractive historic levels and, while we expect continued negative rhetoric on high-profile issues such as drug pricing and industry regulation, we feel these issues are factored into share prices,’ he says.

He’s not kidding. Sam Isaly, managing partner of OrbiMed Advisors, a $4 bn US asset management fund, says P/E ratios are near eight times for many stocks. ‘In 1993 we had an election in the US and there was concern we might get national health insurance, which investors saw as a bad thing, so stocks fell to a P/E of eight,’ he notes. ‘Now we’re back at that level.’

Politics again
This fall in confidence has been attributed to President Bush’s decision to invest $400 bn into the Medicare system over the next ten years, facilitating cheaper prescription drugs for US citizens over the age of 65. Like Hillary Clinton’s earlier proposed healthcare insurance scheme, some investors fear it would mean a less profitable, more regulated market as a result.

To an extent, these worries may be real, but Gareth Powell, fund manager of Framlington’s health and biotech funds, cautions against too much investor depression. ‘You are going to see tighter pressure on price, but the government is also increasing the use of these drugs,’ he says. Aided by skilful marketing departments, sales could well climb if consumers can be persuaded to keep buying new pills.

The drugs industry has not only been knocked by a dearth of new products. It has also been squeezed by reduced patent protection, allowing makers of generic drugs to enter the market earlier. And there is pressure on companies to provide more drug trial transparency for patients, a path the industry – following the rash of recent bad PR on drugs failing to make the grade – can only be forced down.

Yet any discussion about the health of pharmaceutical companies is incomplete without reference to biotechnology. The relationship between pharma and biotech is close and fractious: biotech firms are notorious for crying out for more cash, while pharma often relies on the biotech boffins to help inject new life into its own ageing products and help it save on research time. So far, biotech has not been infected by any of the germs spreading through the pharma sector. ‘We prefer to invest where the innovation is clear, like biotech,’ affirms Powell. A good example for Powell is Amgen, a $60 bn biotech company with several late-stage drug trials; Amgen’s archrival, Genentech, is a $50 bn biotech business Powell is also keen on.

The IR answer
Powell sees IROs fairly regularly when checking out pharma and biotech companies, but he stresses that IROs – particularly in biotech – are often ignorant of the bigger role they could take on. ‘You want company management to be focused on the company, so IROs have this chance for increased responsibility, to be more supportive and have an understanding of what we need,’ he says. ‘I have met IROs from smaller companies I’ve been very impressed with. But, equally, I’ve met IROs from large companies who haven’t impressed. This might be because large-cap companies have to be more secretive about their products but, because of that, it’s harder to give market guidance. Also, large caps are likely to have a much wider base of products, especially if they’ve a huge revenue base.’

Like Powell, Isaly is putting much of his cash into biotech, such as UK-based Cambridge Antibody Technology (CAT). In 1993 Isaly bought into CAT at around £3 ($5.57) a share. CAT’s human antibody technology looked marvelous stuff, the technology promising to potentially treat a range of conditions, including cystic fibrosis and cancer. But by 2000 genomic enthusiasm was all over the place. Worried by mounting investor fervor, Isaly took profits at £30 a share, then saw CAT’s share price surge to £45, then fall – sharply. He recently bought into CAT again, but at £5 a share, and is enthusiastic about Peter Chambre, CAT’s new managing director, who has ‘good skills and fine technical training’.

Isaly, who has two physicians on his 15-strong staff – six staff members have PhDs – is taking advantage of the current drug market downer to buy while many valuations have been smacked. ‘We follow 600 companies, comparing one against another,’ he says. ‘We go through all the published information, the scientific literature and competitor comments. We don’t pay too much attention to brokers, but we like to know what they’re saying. What we care about is the composition of the operating statement, the R&D. Is the firm doing enough research to sustain itself? We’re also watchful of production costs, though the cost of goods in the pharmaceutical sector is not big, perhaps 15 percent of sales. So we’re looking at top line and the acceptance of products in the market.’

As for IR contact, Isaly, confined to a wheelchair since a teenage wrestling accident, admits he doesn’t go out of his way to encourage it. ‘We’re overwhelmed by information,’ he comments. ‘But it’s our job to collect and assess it. We find better quality information from managements, so we want to get in a room with those warm bodies and see them direct. But we also want them to be running their business, so it’s a balance of theatre and performance.’

Though the pharmaceutical sector has taken a pummeling, there could be some residual encouragement – in the improbable form of Gordon Brown, the British chancellor of the Exchequer. On December 1, 2004 (World Aids Day), Brown committed the UK government to buying an AIDS vaccine as soon as one becomes available. Increased awareness of third-world disease and a commitment to reduce suffering, particularly of young children, is also more commitment to drug spending – witness Bill Gates’ recent $750 mn commitment to the non-profit Global Alliance for Vaccination & Immunization, matched soon after by a pledge from the UK government.

My-Linh Ngo, an SRI analyst at Henderson Global Investors in London, thinks the West’s stung conscience over the developing world could have profitable side effects for drug companies prepared to invest there. ‘Obviously, drug firms are there to make money, so the ability to pay is important,’ he concedes. ‘That’s why the industry has not focused on developing or emerging markets. Lack of healthcare infrastructure is another reason. But things are changing and, as quality of life improves, so will the quality of the market. Look at Brazil, China and India – those markets are really developing now. We are even starting to see companies that have not had relevant products for these markets invest resources in it. AstraZeneca, for example, is now doing TB research. There are real benefits to be gained.’

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Andy White, Freelance WordPress Developer London