When investors hear talk of 'big pharma' it's easy to picture behemoths such as AstraZeneca (AZN) and GlaxoSmithKline (GSK) - stalwarts of the FTSE 100 for years. But, on closer inspection, the four big pharma constituents in that index (five if you count medical equipment company Smith & Nephew (SN.)) have never looked more different.
In March, it was announced that generics business Hikma Pharmaceuticals (HIK) would join the index, replacing Tullow Oil when the dual-listed driller was hit by the downturn in the oil price. The move was based on a change in the respective groups' market capitalisations. At the time of the FTSE Group's review, Hikma's £4.9bn market value far outstripped Tullow's £3.3bn.
From that point, there were four drugmakers in the FTSE 100: AstraZeneca, GlaxoSmithKline, Shire (SHP) and Hikma. This illustrates two interesting phenomena: investors are clearly still hungry for healthcare and the face of big pharma is becoming increasingly diverse. Admittedly, AstraZeneca and GSK have very similar business models - particularly from an historical context. Respiratory medicines are the backbone of both product offerings. And both groups have been under pressure to come up with next-generation respiratory products to offset expired patents and competition from biotech start-ups. But both Astra and GSK have also faced calls from investors to boost future growth through innovative - and highly profitable - new medicines. This is where the similarities come to an end.
Last year, Astra gave its shareholders a timeline: 2017 is still the target for the group to start re-reporting top-line growth. In the meantime, its future product pipeline is top of the agenda. Last year, US rival Pfizer (US:PFE) made an aggressive bid for the group, which management repeatedly turned down. Suspicion was rife that Pfizer went after Astra in pursuit of tax-inversion benefits. In fairness, however, Pfizer's track record in developing new oncology products is enviable compared with GSK's.
By contrast, GSK has tried satiating shareholders in an entirely different - and arguably not as successful - way. Last year's bribery scandal and subsequent fine in China dealt chief executive Andrew Witty one of his worst PR blows to date. It also overshadowed a sensible and well-received asset-swap deal which GSK agreed with European group Novartis earlier in the year. Shareholders are still looking for answers when it comes to GSK's future. The group offloaded its oncology arm for $16bn to Novartis as part of the deal, only to sign a seven-year partnership agreement with Oxford-based oncology specialist Adaptimmune two months later - albeit worth a minimal £209m by comparison.
Comparing the share price performances of GSK and AstraZeneca, it's clear which one the market has placed its bets on. AstraZeneca's share price was boosted by the speculation surrounding a deal with Pfizer, but it has held on to most of that deal-driven hype, with the shares trading at more than £40 apiece. Shares in GSK have been on a rollercoaster ride, as management flip-flops on the best way to deliver a tangible growth strategy. A clear example was a possible IPO mooted for GSK's fast-growth HIV business - Viiv Healthcare. Unfortunately, those plans were eventually shelved in May. The shares were marked down accordingly and - at 1,349p - GSK's shares now trade close to their three-year low.
AstraZeneca was not alone during last year's M&A rumblings. Unlike the thwarted Pfizer-Astra tie-up, Shire agreed to a merger with US group AbbVie (US:ABBV) last Summer, before the deal fell through in October. Another victim of tax inversion, Shire has been busy recovering its reputation as a buyer in the market rather than a potential target. In January, it followed through with the acquisition of New Jersey-based NPS Pharmaceuticals (US:NPSP) - a deal that was placed on the backburner when AbbVie came knocking.
The NPS deal is important for another reason. The US company is another rare diseases specialist and Shire was attracted to the company's short bowel syndrome product - GATTEX - which is already approved in the US and Europe. Including NPS in current forecasts, management predicts product sales will grow in the mid-to-high single digits (at constant currencies) this year.
Finally, FTSE 100 newcomer Hikma offers a different business model to investors. Investors in traditional pharmaceuticals are well aware of the threat that generic copies of once-exclusive drugs pose to the likes of AstraZeneca and GSK - but this is Hikma's specialism. Founded in Jordan in the mid 1970s, Hikma remains the largest regional pharmaceutical company in the Middle East and north Africa. But, for that reason, the shares are sensitive to the political landscape in a way that European pharma stocks aren't. Security concerns aside, recent trading at Hikma was a mixed bag at best. The group's strength is its injectables business, which makes three-quarters of its revenues in the altogether more stable region of the US. But revenue from generics dropped 19 per cent last year as a result of intense market competition and tough 2013 comparative figures, while the branded business blamed stagnant revenue growth on a restructuring programme in Algeria and political disruption in Iraq and Libya.
Favourites: Our favourites remain AstraZeneca and Shire. The former offers the most compelling growth story from traditional big pharma, as well as a dividend yield of more than 4 per cent, making it a steady income earner at the same time. The latter has long been hailed as a niche business and Shire's foothold in the rare diseases business helps set it apart from its FTSE 100 rivals. Its shares don't offer the same reliable income as AstraZeneca or GSK, but the share price has more than doubled in the past three years. For faster growth it's also worth seeking out the lower end of the market, and specifically Aim, which hosts a number of high-potential - albeit higher-risk - biotech investments.
Outsiders: For now, our outsiders are GlaxoSmithKline and Hikma. The former has a number of challenges it must overcome: a PR disaster in China, how to harness growth from its HIV business, and how to stimulate growth in the core respiratory business. There are also murmurs in the City that chief executive Andrew Witty might not be given time to see any of the planned changes through. Meanwhile, Hikma will probably need to come up with stellar trading figures to offset negative investors sentiment about the Middle East security situation.
| IC view: London's pharmaceuticals sector looks more diverse than ever, with four large players staking claims on the FTSE 100 index. But that means stockpicking can also be more nuanced than simply taking a core holding in AstraZeneca and GSK. The sector isn't cheap, either, with an average forward PE ratio of around 18. But one pays for quality and growth prospects here - not to mention a healthy dose of income at times - and so 'buying on weakness' is a suitable strategy for buying company shares in this sector. Patience is required, though, as these stocks tend to be well supported. It's also conceivable that investors could benefit from the periodic upsurge in consolidation within the sector. You could argue that when stocks are reaching fair valuations - or even a perception thereof - this is a particularly good time to focus on potential takeovers. This is hardly an investment strategy in the real sense of the word, but the industry is prone to periodic bouts of M&A fever - or so it seems. |
