Sector analysis: Pharmaceuticals - are drug companies on a high?

Spending billions on development before you even bring your product to market could be enough to detract investors, yet for the drug companies this sort of gamble can be worth every penny.

In its annual review, industry analysts EvaluatePharma forecast that by 2022, worldwide drug sales would hit $1.06 trillion.

The largest share of revenues comes from branded drugs that are still under patent, but generic drugs are still holding their own with sales expected to increase from $73bn in 2015 to $115bn in 2022, amounting to 10.2% of prescription sales.

Pfizer's Lipitor is the most successful drug of all time, netting $148,744bn in total sales since it hit the market. Currently, the most expensive drug in the world is Glybera, a gene therapy drug by Dutch company Uniqure. The drug costs upwards of $1 million per year.

Pharmaceutical industry trends

Overpricing, environmental issues, more demanding regulatory requirements and drug patent expirations are predicted to be the key trends affecting the pharmaceutical industry in 2017.

The cost of research and development (R&D) is still a big issue. The Evaluate World Preview 2017 stated that the cost of bringing a novel therapy to market has increased over the past ten years and stands at an average of $4bn.

This is something that puts a question mark over the long-term sustainability of some pharmaceutical companies.

What is the drug pipeline?

The drugs pipeline is the name given for the number of drugs that a company has at different stages of trial testing. Investment in the drug industry can be a waiting game as drugs can spend 10 to 15 years in development before they are brought to market.

To be approved, all drugs need to have undergone rigorous testing that fall under four phases: discovery, pre-clinical, clinical trials and marketing (or post-approval). After this lengthy process, only approximately 20% of drugs make it to the marketing stage.

The cost of R&D is still a big issue. Credit: Shutterstock.com

Orphan drugs

The pharmaceutical industry seems to have been focusing its R&D on orphan drugs in recent years. According to the EvaluatePharma report, the orphan drug market is expected to almost double during the 2016-22 period, peaking at $209bn in 2022.

As treatments for these ultra-rare diseases can cost $200,000 or more per patient per year, it is a lucrative market with revenues even rivalling the traditional blockbusters. The cystic fibrosis drug, Kalydeco, for example, is priced at £14,000 per patient per month.

Add in the 1983 Orphan Drug Act, bringing with it seven years of market exclusivity to the usual five as well as tax incentives and research design support, then you can see why investors are taking note.

The lack of other treatments in the area also helps to speed up regulation. This provides a platform for further drug development in a specialised market and the higher market value of orphan drug companies reflects this.

In addition, initiatives like the UK’s 100,000 Genomes Project will help see the growth of personalised medicine. These genetically tailored drugs may be costly to develop, but have the potential to bring in huge amounts of revenue.

What affects the sector’s share prices?

The mid-2015 record of the sentinel Nasdaq biotechnology index was not repeated in 2016. Policymakers and analysts claim closer questioning of drug pricing and tax avoidance could have dampened investor enthusiasm.

According to EvaluatePharma, pricing is the one factor that could keep denting investor sentiment, and cause further cooling of the sector.

Antonio lervolino, head of forecasting at Evaluate, said: “The continued political and public scrutiny over pricing of both the industry’s new and old drugs is not going to go away and we are starting to feel the impact now.”

What can make one company buck the trend?

The most successful companies seem to be those that have a firm hold on a specialised area. Examples include Achaogen that has focused on identifying and developing products to treat multi-drug resistant gram-negative infections and in December 2016 it witnessed a breakout for stock.

Biopharmaceuticals accounted for 35% of all new drug approvals in the US from 2006 to 2016, and according to new assessment from the Tufts Center for the Study of Drug Development, this will not halt.

Ronald Evens, adjunct research professor at Tufts CSDD, who conducted the analysis, said: "Given the historically high, 74% Phase III-to-approval success rate of biologicals in late stage development, and the extensive biotech product pipeline, the high pace of biotech product approvals will likely continue through the next decade.”

What can make a company's share price fall?

Failure to get regulatory approval for an expensive new drug can have a big affect on share price for a pharmaceutical company.

The patent cliff is also a factor. This refers to the drug company drop in revenue after a drug patent expires and is something that Investors should pay close attention to.

Bernstein analyst Tim Anderson thinks a period of contraction, tied to patent expiries, is inevitable, and that it could lead to a new and smaller base for achieving growth. He predicted that: “only a few lucky ones appear able to achieve organic growth.”

Many companies can withstand the profit losses that accompany the arrival of generic competitors, so long as their pipeline is solid and management strong.

Drug patent expiries, according to EvaluatePharma, could wipe out $194bn worth of pharma sales during 2016-2022.

What should I look out for in company accounts?

A robust pipeline of drugs is essential as regulation challenges and a drug patent expiration can affect the pipeline at any point.

Looking at a company’s pipeline allows investors to assess their ability to not only discover new drugs, but their record of bringing drugs to the market.

The lengthy testing period of any new drug means a pharmaceutical company must be stable in order to stay competitive in the marketplace.

What else is there to watch out for?

Mergers and acquisition activity is rife in the pharmaceutical industry. This is because many larger companies will acquire smaller ones to grow their drug pipeline. Oncology has been an active area, with assets often acquired at earlier stages of their development

Mergers and acquisition activity is rife in the pharmaceutical industry. Source: shutterstock.com

Last year Shire acquired of Baxalta, a company with a well-established haematology portfolio, for $32bn. Following the deal, Shire recorded a 109% jump in sales during the first three months of the year to $3.5bn.

It projected that the combined company would generate approximately 65% of its total annual revenues from its rare disease products, rising to more than $20bn by 2020. The latest results lifted Shire's shares by 3.5%, to £46.98, valuing the company at £42.6bn.

According to Graham Robinson, a partner at Skadden, mergers and acquisitions in big pharma is largely driven by the availability of attractive targets. He said: “The capital markets are rewarding acquirers for smart acquisitions. Some acquirers’ stocks have increased following acquisition announcements.

“In addition to orphan drugs, investors appear especially enthusiastic about transactions and investment opportunities in the following sectors: cancer, CNS, autoimmune, infectious disease, cardiovascular, pulmonary and ophthalmology.”