Missing forecasts, clinical trial failures and pricing scandals. It's fair to say 2016 has been hard for big pharma. But political surprises both at home and in the US have offered the sector a helping hand, and despite a plethora of disappointing updates from individual companies, the global pharma index has stayed afloat - just.
Britain's vote to leave the EU and Trump's victory benefited UK pharma
Look beyond the headline index movement, however, and the story is distinctly murkier. AstraZeneca (AZN) has been one of the worst performers this year. The UK's second-biggest pharma group suffered during the third quarter as top-selling statin Crestor faced increased competition from generic copies. The resultant sales knock caused a significant hit to quarterly earnings. But Astra wasn't alone in missing market forecasts. Fellow FTSE 100 constituent Shire (SHP) reported an uncharacteristic drop in earnings per American depository share (ADS), caused by the hefty costs associated with integrating the recently acquired Baxalta. The bad news continued across the pond where Allergan (US:AGN), Gilead (US:GILD) and Eli Lilly (US:LLY) all missed earnings expectations too.
Pricing controversies also blighted the industry this year. The latest controversy was stirred up by Mylan (US:MYL), which ramped up the cost of its EpiPen just in time for the 'back to school' rush in September. Suddenly, Mylan joined Valeant (US:VRX) and Turing Pharmaceuticals as one of the least popular companies, disliked by patients, regulators and peers who suggested it had tarnished the reputation of the industry. We suspect it's not just a damaged reputation that got pharma executives' backs up. Pricing scandals have spurred regulators into action and a number of pharmacy benefit managers - the go-betweens for healthcare companies and insurers in the US - have said they will cease covering drugs they believe are overpriced. That said, pricing fears have abated since the victory of President-elect Donald Trump, whose stance on the issue wasn't nearly as strict as campaign rival Hillary Clinton. In the days after the US election result, global pharma stocks rallied.
But no amount of political relief could save Eli Lilly, Bristol-Myers Squibb (US:BMY) or AstraZeneca from disappointing clinical results, and the subsequent downward reaction in their share prices. BMS's cancer drug, Opdivo, failed to perform better than traditional chemotherapy in a final phase clinical trial for lung cancer patients. Following this, Eli Lilly revealed that its highly anticipated Alzheimer's drug, Solanezumab, failed to delay symptoms of dementia in Alzheimer's patients. Astra's clinical disappointment was easier to take: it only had to pause clinical trials into its cancer drug durvalumab for a week after patients reported worrying side effects. But that didn't stop some investors jumping ship. The share price is down by a fifth since September.
Fans of big pharma can take solace in the fact that sentiment among analysts and experts remains bullish. Based on the promise of several drugs still in the development pipeline, many London brokers look on the sector as enormously underrated and due for a recovery in 2017.
How Big Pharma is dealing with the big problems
The UK's three main pharma companies have employed different strategies to deal with the sector's challenges. Globally, however, these strategies are not unique. The US - the world's largest healthcare market - offers clues as to which group could win out in the long term.
Consumer healthcare: GlaxoSmithKline and Johnson & Johnson
The strategy to shelter itself from falling profits by bulking up its consumer healthcare division has seen GlaxoSmithKline (GSK) heavily criticised over the past couple of years. But GSK isn't the first pharma company to employ these tactics. US behemoth Johnson & Johnson (US:JNJ) also has a sizeable consumer healthcare division, which has helped it to grow despite a far less impressive research and development division than some of its peers. We don't necessarily think this is a bad strategy. In fact GSK and J&J were two of the very few pharma companies to report strong third-quarter results. But earnings at J&J do lag those of pure-play pharma peers and GSK - with its lack of investment in newer, more high-risk drugs - could be heading that way too.
A cure for cancer: AstraZeneca and Merck
With advances in science come huge leaps in human understanding of cancer and cancer treatment but, to date, no company has managed to capitalise on this by launching a top-selling drug. Someone has to lead the race. In the US it's Merck (US:MRK). Its drug, Keytruda, has already reported strong early sales given its potential to treat 23 different types of cancer. In the UK, Astra is far and away the most impressive oncology company and boasts a strong pipeline of future cancer drugs, many of which are due to announce clinical trial results in 2017. The profit potential associated with multiple high-profile oncology drugs is the reason we like Astra shares and consider them hugely undervalued at present. Granted, there are significant risks associated with late-stage drugs trials - especially true when Astra is banking on them to buck up earnings - but we think this has been priced in following the recent share price slump.
Growth through acquisition: AstraZeneca and Gilead
Astra went on a full-blown shopping spree in 2015 when it bought three companies to bulk up its drug development pipeline. This is risky should the clinical outcomes be bad, but building a strong roster of future medicines through acquisition could prove savvy. In 2011 Gilead bought a little known pharmaceutical group for $11bn (£8.6bn) for its hepatitis C drug Solvaldi - a price that seemed absurd at the time. But in its first quarter Solvaldi made $2.27bn of revenue. Now, as the world's top-selling drug, it's more than made back its original investment. We like the acquisition strategy as, on the whole, the small biotech target companies are better suited to developing innovative new drugs that capitalise on improvements in science. These companies rarely come cheap, but buying drugs at a later stage reduces the risk associated with early-stage clinical trials.
Rare diseases: Shire and Pfizer
For a long time, pharma companies looked for the largest disease and patient populations as potential revenue streams. But those days are gone. Orphan drugs - medicines for rare diseases without existing, effective treatments - have proved themselves to be viable moneymakers. In the US, Pfizer (US:PFE) has built itself an impressive portfolio of specialist drugs with long exclusivity periods, keeping generic competition at bay. This has helped keep earnings high, while other companies are busy fighting off competitor products. This is good news for Shire which, following the Baxalta acquisition, is one of the world's largest rare disease specialists. Shire shares are looking very cheap - especially considering the huge earnings boost provided by the new Baxalta products - and that's why we remain buyers.
