The pharmaceutical sector had its fair share of ups and down during the third quarter, particularly companies with exposure to the scandal-ridden Chinese market. Only a handful of European firms are forecast to achieve anything like double-digit earnings and revenue growth over the next 12 months, but there are signs that the industry has a growth story to tell again as the next generation of biological medicines comes through to refresh previously tired looking product pipelines. The truth that many company executives have come to realise is that specialisation is now what counts in the race to stay ahead of the generic competition.
Finding the savings...
As irritating as quarterly results reporting can be, the third-quarter season did reveal some interesting trends in the UK pharmaceutical industry that will have a major bearing on how investors view the main players over the next year. The basic message is that increasingly specialised companies attract the most interest.
Among the UK's big three, Shire (SHP) turned out to be the darling of the market this year - the shares have staged a 50 per cent recovery since reaching a low in the spring - as the company benefits from a combination of medicines acquired several years ago reaching sales maturity. Newly appointed chief executive Flemming Ørnskov has overseen a cost-savings programme, too, which will add several percentage points to full-year earnings growth and perhaps explains why the market has reacted so positively.
Astra's rebound?
AstraZeneca (AZN) hit the headlines before its third-quarter update after reports that some major banks had advised clients to close out short positions in the hitherto struggling pharmaceutical company. The evidence of the past month or so suggests that short selling has stayed comparatively low at around 4.9m shares, a slight rise compared with September's 4.1m figure, but not indicative of feverish activity. The reason the bears may be paring their positions is that Astra's frenetic acquisition activity over the past 12 months has given its R&D department a renewed urgency. This represents entirely the strategy being pursued by chief executive Pascal Soriot who wants to bolster the company's late-stage pipeline by acquiring products that are close to final regulatory scrutiny.
The first fruits of this strategy could be products produced by Ardea Biosciences, which Astra bought in 2012 for about $1.26bn (£777m). The acquisition added a Phase III trial drug candidate in Lesinurad, which is being developed as a treatment for chronic gout. US and EU regulatory filings are planned for the second half of 2014. These applications will be followed in quick succession by filings for anti-cholesterol drug Epanova, which came with the $443m buyout of Omthera, along with respiratory drug PT003 from Pearl Therapeutics that cost Astra $560m.
GSK in the dragon's den...
GlaxoSmithKline's (GSK) problems in China were given a more concrete figure in the third quarter - sales there collapsed by more than 60 per cent in the wake of a much-publicised bribery scandal. The overall effect on group sales, though, was reckoned by analysts to be no more than 1 per cent, reflecting China's relatively small market for expensive western-style medicines. This is why broker earnings downgrades were minimal and investors are likely to ascribe more value to the company's increasingly robust pipeline - the next major regulatory decision for Glaxo is the Food & Drug Administration's (FDA) almost certainly positive decision for Anoro, a chronic obstructive pulmonary disorder drug, which is due by the 18 December. In addition, there will be Phase III trial results for cardiovascular drug darapladib before the end of the year. If positive, there could be significant upgrades to earnings forecasts.
Bitter pills for US investors...
The US pharmaceutical sector is not an area we have looked at regularly, but UK sector observers traditionally feel a sense of envy at the US's seemingly limitless resources and entrepreneurial zeal. However, the third quarter was a very bumpy ride for some of the biggest American players and emphasised, yet again, that despite years of cutbacks and retrenchment, many of them are still bigger than their currently declining sales can justify.
The world's second largest pharmaceutical company by market capitalisation, Pfizer (US: PFE) has been hit by a patent cliff larger than the combined sales of smaller companies, particularly after patents expired for its blockbuster cholesterol drug Lipitor in 2011 and $13bn of sales halved overnight. The recent third quarter showed that sales were down 2 per cent to $12.6bn, but the interesting news was that the company plans to issue separate financial reports for each of its main business units next year. That has sparked speculation that management will divest or spin-out some its businesses to generate the cash need to prop up its ailing product pipeline. The division most likely to be shed is the "mature" products division which includes those medicines that have seen their patents expire.
The overall US weakness also affected Merck (US: MRK) after quarterly profits dropped 35 per cent to $1.12bn following a series of patent expirations. The company is yet another large cap with a sluggish development pipeline and management also effectively put a 'For Sale' sign over its animal health and consumer products divisions to raise cash to restock its medicines cabinet. Eli Lilly (US: LLY) is in much the same position, though the effects will be more dramatic in 2014, as it is due to lose patent protection for its best-selling anti-depression drug Cymbalta in December. This, combined with the expiry of osteoperosis drug Evista next in the spring will knock 25 per cent from profits in 2014, according to analyst estimates.
IC VIEW:
Overall, the picture is quite mixed but, for this year at least, UK companies, along with European firms like Denmark's Novo Nordisk (DK: NOVO), have the greatest scope for earnings growth for the first time in a decade.
