For pharmaceutical and healthcare companies 2007 was truly a case of the good, the bad and the ugly.
On the bright side, investors made gains on companies in the medical technology and healthcare services markets where businesses are relatively easy to understand and have dominant positions in their markets. Highlights for the industry included the announced takeover of medical technology group Gyrus for about £935m by Japan-based conglomerate Olympus as well as the 70 per cent rise in the share price of Southern Cross Healthcare. The latter’s rise was tempered though by uncertainty surrounding the unwieldy domestic healthcare sector, which saw some stocks in the sector crash after the NHS backtracked on contracts.
But on that note, it was definitely the gloomier aspects that dominated comment on both industries in 2007 and provides prospective investors with opportunities, but also reason to pause and reflect upon the type of return they should expect.
In the pharmaceutical sector, the brash approach of the past - where investors looked for and achieved quick and large returns from blockbuster drugs and takeovers - is proving to be more allusive. Still, a more conservative and patient investment philosophy should provide reward in the future even though the industry’s biggest players, GlaxoSmithKline and AstraZeneca are forecast by analysts to produce flat earnings per share growth over the next two years. In fact, after seeing their share prices fall last year, the dividend yields provided by these two giants of around 4 per cent now looks attractive, especially considering the earnings certainty implied by combined revenues approaching £50bn.
A key issue clouding the industry outlook is the increasing regulatory hurdles to drug approval due to safety concerns. This is a result of high profile litigation over side-effects from blockbuster drugs - including Merck’s arthritis drug Vioxx, which was taken off the market in 2004. For example, in 1998, 24 drugs were approved by the US Food & Drug Administration after $27bn (£13.5bn) was spent on research and development (R&D). In contrast, last year R&D had reached $64bn, yet only 13 drugs were approved by regulators.
Another thorn in the side of big pharma is the rise and rise of generic drug producers, capitalising on the expiration of patents for blockbuster drugs. Even long term over-achiever Shire is having problems due to the patent expiry of its blockbuster drug for attention deficit hyperactivity disorder (ADHD), Adderall. Its shares rose 22 per cent in the first eight months of 2007 to reach 1,310p, but have since fallen 15 per cent from this level on concerns that Adderall’s replacement, Vyvanse, is not filling the $250m sales hole its expiry has left.
In contrast, Jordanian generic pharmaceuticals company Hikma Pharmaceuticals has been benefiting from the trend. Other companies whose earnings were deemed to be easy to understand for investors also benefited, such as condom manufacturer SSL International, whose profit growth has been underpinned by market innovation cost-cutting. The company's share price also benefited from bid speculation.
In investment markets it is often said that past returns are no guarantee of the future, but given the current uncertain environment, pharma companies look like a safer bet with valuation underpinned by decent yields and low earnings multiples.
