Time to Invest in Pharmaceuticals?

The prices of many pharmaceutical companies have been beaten down by Wall Street in recent months. With companies like Pfizer (PFE), Schering-Plough (SGP) and Bristol-Myers Squibb (BMY) reaching lower lows, one has to wonder when the pain will end as these companies are now significantly undervalued.

The game of Wall Street is far from what many believe is true of the strong-form efficient market hypothesis – that the stock market efficiency causes share pries to always incorporate and reflect all relevant information. Since a majority of the market is comprised of traders’ expectations of future prices based on past information, the underlying human element disputes this theory. What typically happens in an economic cycle is that the stock of a company or even the value of an entire industry grows oscillates beyond fair value.

For example, if company A trading at $10 is in an up cycle with valuation of $20; the stock usually rises way above that valuation, perhaps $30. When the same stock hits a down cycle and is still valued at $20, the price is often battered to $10. In the long-term, the stock price may stabilize near the consensus value, but in the short term you are more likely to see fluctuations.

Many investors have abandoned the pharmaceutical industry lately due to the lack of drug pipelines, blockbuster patent expirations, a more stringent FDA, generic competition, research failures, scandals and drug safety concerns. Because of this, many companies have been battered to the ground.

Big Pharma have realized this evolving market place and many are undergoing multi-year transformations to change the way they do business.

For example, many of them are now focused on cutting out the “fat” that they’ve accumulated over the years. Companies are also developing new systems, technologies and sales tools to combat the increasingly hostile environment. Instead of focusing on developing blockbuster drugs, companies are spreading their resources into more focused indications on smaller patient populations. They’re entering newer markets, particularly in Asia where significant growth opportunities exist. They’re also participating in more JVs, co-promotes, and acquisitions to prop up their pipelines. Finally, companies are outsourcing many activities like R&D, clinical research and sales to third-parties.

It’s not uncommon to see industries undergo drastic transformations like the one taking place for pharmaceuticals; we’ve seen it happen previously be it in Consumer Goods, Automotive, or Telecom just to name a few. Certainly this is just part of the cycle that every industry needs to go through.

The pharmaceutical industry is not only attractive for its high-paying dividend yields; a weaker US Dollar has helped overall earnings due to strong sales in international markets. In addition, many companies are currently trading at low multiples (to earnings and to sales). Valuation analyses suggest that many companies are now cheaper than the sum of their parts.

Instead of looking for the next blockbuster, the prudent investor will look for where true value exists. You’ll probably not witness huge returns like those after Hillary’s universal healthcare collapse during Clinton’s presidency; there are still great benefits to be reaped however. In the end, how can you beat a business that makes a pill for a few pennies and sells for a few dollars? The economics are just too good to avoid!

Disclosure: none

Comments

[businessguy88]

one of my major concerns about this upcoming year is how the election will pan out. If universal healthcare turns out to be a real possibility, then pharma companies are going to find it even tougher as their biggest customer will be the government.

[BlueOkie]

Everyone wants universal healthcare, inexpensive/affordable healthcare and quality healthcare. You can only have two of them at any one time. To increase one it is at the expense of one or both of the other two. More and more doctors are beginning to refuse government sponsored health care programs, e.g. Medicare. Too much paperwork and too little pay.

[User 245013]

Howard,
Good article, except for one point. It takes about $1 billion to get a drug launced AND THEN it costs a few pennies to produce. Just trying to keep you journalists honest (a toughjob nowadays).

[Howard Sun]

User 245013 - I'm not a journalist. And yes I am aware that it takes many years of research and hundreds of millions in development costs to bring a drug to market. Certainly many drugs remain unprofitable for many years, and sometimes their entire lifetime post-launch.

Hence why many large pharmas are acquiring or partnering with research facilities and other drug companies.

[mkreisel]

Where does everyone get this $800-1000M per drug number? From the pharmaceuticals themselves of course!

Can that number be fully trusted?

[RohanRider]

to; mkreisel

Just pick up a copy of the NJofM or Harvard review. They have no bias when it comes to reporting it takes 800 million to 1.04 billion per drug to market. This is very well know. This is all in the company financials, just read. If they are lying, well then all the accounting firms are subject to huge fines. Not that this can not happen, but unlikely with SOX at this point.

I work in pharma, it is real. Its only going to get more and more expensive as the FDA has increased its safety analysis. I see it at 1.2 billion by 2012. The FDA will stiffle progress in the USA, if dems take charge it will be worse. The EU, China, India, Brazil and Russia will account for most of the growth past 2010.