In a recent book, Ben Goldacre, a British doctor and author of “Bad Pharma”, aired his decidedly negative views towards the Pharmaceutical industry, having spent much time being sold-to by Pharmaceutical representatives. He spoke of all the ways in which Pharma was “broken”, buried in trials of drugs that didn’t work all-the-while shrewdly dismissing their own findings to the wider world. What he failed to recognise, however, was an industry in the throes of change. John Bennett, Fund Manager of Henderson European Focus Trust, believes we’re in the midst of a bounce-back in its fortunes.
The problem niggling investors for years was the so-called “patent cliff”. Key drugs – the all-important cash-cows to firms – were edging ever closer towards patent expiry and the point at which generic drugs firms can sell them at a fraction of their former price; the well of new block-busters to replace them appeared to be running dry. Dovetailing with woes of strategic and risk mismanagement, and changes such as Obamacare in the US to drive down profitability, the sector fell out of investor favour as many started to predict a serious downturn.
John, however, has been looking to the industry for value since 2010. Since then, it has re-rated from the depths of deep value through to more reasonable earnings multiples. But his investment thesis believes in the continuing outperformance for a further 6 or 7 years, and this belief is buried in a number of drivers of growth in the sector.
It starts with a shift in the Pharma business model. The strategic change needed to ride the patent cliff has been made possible on account of refreshed management across most of the major pharmaceutical organisations.
New chief executives are focusing on more targeted treatments rather than big block-busters. They’re looking to improve the performance of current ones for example where newly drug-resistant strains of diseases required new versions of an existing drug. And they are diversifying their revenue streams and strengthening the product offering into areas of consumer and animal health, vaccines, diagnostics, and drugs less exposed to patent expiry such as low-cost generics. As it stands today, around 44% of revenues from European Pharmas come from products that aren’t patent dependent drugs – by 2020 it will be more than half. Sanofi lost €2.2bn in 2012 through patent expiry; since it has recouped all of its losses via diversification.
Pharma’s approach to risk is also distinctly more shareholder friendly. Research & development (R&D) is obviously risky business – the rejection of drugs in later-day trials can sink costs in the hundreds of millions of pounds – but large Pharma is reducing the risk through strategic partnerships and collaborations with other companies, deepening the pool of knowledge brought to the table. Alongside the outsourcing of services it enables management to streamline the business model, dumping the years of bureaucracy that has been building in the system.
With better management, more diverse streams of revenue and a better approach to drug-development risk, certain European companies are poised to benefit. One area is in the support of our ageing populations, a result of the baby-boom years and improving medicine. Age-related health concerns, obviously, will increase with age. Research from the survey of Health Ageing and Retirement in Europe found that the majority of people over 50 in Europe have at least one chronic health complaint. In the US nearly half of American adults over 65 have a persistent health issue, according to the Centre for Disease Control (CDC). Such issues include diabetes and hypertension, affecting over 350 million people worldwide. Medicines such as Lantus and NovoRapid, created by Sanofi and Novo Nordisk respectively, both European firms, lead the field.
Of course you have to pick the right stocks. John points to two in particular: Sanofi and Roche. The former is a €100bn French company whose product line-up is vast and, as well as drugs for diabetes such as Lantus, contains various other targets in oncology, multiple sclerosis, and vaccinations. Roche, a Swiss firm, at €164bn, has a line-up that includes drugs in cardiovascular diseases, cancer, inflammatory & autoimmune diseases, and infectious disease.
It’s true the industry has had some scandals in the past and been unpopular with consumers and investors alike – Pfizer’s payment of $491m in the US due to a corruption probe highlights some of its hangovers – but John holds tight the belief that over the long term Pharma’s fortunes have turned for the positive, translating into a core investment theme for Henderson European Focus Trust.