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FTSE 350: Big pharma needs big launches in 2017

Pharma looks in better shape given the outcome of the US election and the defensive nature of their high dollar earnings
January 26, 2017

Analysts, fund managers and company executives all agree that 2016 was tough for the pharmaceutical industry. The ‘patent cliff’ – when several top-selling drugs lost their intellectual property protection, and thus faced more competition from cheaper copies – hit the UK’s pharma giants hard. What’s more, industry stalwarts struggled to launch any major new drugs to make up for the loss in sales. Add this to the costs of integrating acquisitions made in the previous year, and big pharma’s financial situation looks precarious.

And yet, political surprises have largely played in favour of these big dollar-earning stocks. Therefore, share prices of FTSE 350 constituents didn’t take the tumble in 2016 that might have been expected. Now, as 2017 plays out, things are looking up.

GlaxoSmithKline (GSK) has certainly got itself back on track. The UK’s biggest pharma group has been one of the few companies in the industry to deliver consistently good financial reports throughout the year. This can be largely attributed to its growing consumer healthcare division, which has helped keep earnings aloft as several top-selling drugs lose exclusivity. The new chief executive set to take the reins in February also has a consumer healthcare background, hinting that this division will continue to play a prominent role in GSK’s strategy. Good thing, too: its pipeline of new drugs is less than impressive, with just a handful of medicines expected to launch over the next few years.

We’ve already said that 2016 might have been the year that traditional UK big pharma ceased to be. With GSK focusing more on its consumer healthcare division, its closest competitor AstraZeneca (AZN) moved to the other end of the spectrum, funnelling investment into innovative new drugs. Astra – more so than GSK – has used recent improvements in scientific understanding to its advantage and created an attractive pipeline of new drugs, particularly in cancer treatment.

Shire (SHP) also has a strong drugs pipeline. The group’s $32bn (£26.1bn) acquisition of Baxalta, signed off in June last year, has turned the group into the world’s largest rare diseases specialist and brought in a vast array of new drugs. The integration of Baxalta isn’t yet complete (meaning further costs in 2017), but it is progressing ahead of schedule.

The key area of focus for both Astra and Shire in 2017 will be the progression of their respective drugs pipelines. Both companies are relying heavily on positive clinical trial results and new drug launches to help them to achieve their ambitious revenue and earnings targets.

Aside from Shire’s mammoth merger, big pharma consolidation slowed in 2016. Instead we’ve seen an increase in small deals where companies buy or sell drugs to suit their expertise. Astra has been a key contributor to this, selling many ‘non-core’ drugs in a bid to prop up cash reserves. This is a trend expected to continue in 2017. Larger deals last year included Vectura's (VEC) purchase of listed peer SkyePharma and Hikma's (HIK) less successful acquisition of US generics business West-Ward Columbus. It’s likely major M&A activity will continue to slow next year – particularly now that fresh US corporate tax laws have made it less attractive for pharma giants from across the pond to make UK takeover bids.

Pure-play biotech remains conspicuous by its absence in the FTSE 350. Last year wasn’t a good year for these high-risk stocks, as market turbulence sent investors hunting for more reliable holdings. The clinical disappointment from Circassia (CIR) also did little to help sentiment. The biotech group, which floated with high expectations a few years back, crashed out of favour in the summer after it failed a pivotal drugs trial. But funding looks to be in decent shape: the UK government has pledged to do more to help companies with their research, meaning 2017 could turn out to be an exciting year for UK biotech discoveries.

Concerns about a clampdown on drugs pricing does, however, remain a concern. President Donald Trump pledged before his inauguration to rein in the exorbitant costs of some drugs in the US, saying pharma groups had been “allowed to get away with murder”. That said, innovative drugs companies, which focus on new treatments for serious diseases, are likely to be unaffected – especially if they can claim unrivalled efficacy in the market.

Price (p) Market value (£m)PE (x)Yield (%)1-year change (%)Last IC view
AstraZeneca4,58157,95415.54.48.8Buy, 4301p, 15 Dec 2016
BTG5942,28628.10.0-2.1Hold, 599p, 16 Nov 2016
Dechra Pharmaceuticals1,4431,34333.61.346.1Buy, 1422p, 18 Jan 2017
Genus1,7401,06428.71.225.0Hold, 1968p, 08 Sep 2016
GlaxoSmithKline1,56176,62218.45.114.3Hold, 1637p, 22 Sep 2016
Hikma Pharmaceuticals1,9564,69420.61.2-1.8Hold, 2302p, 24 Aug 2016
Indivior 3102,23510.23.092.1Hold, 345p, 17 Aug 2016
Shire4,50440,721270.46.0Buy, 4344p, 15 Dec 2016
Vectura Group140946170.0-18.7Buy, 151p, 23 Nov 2016

 

Favourites: We think AstraZeneca and Shire are both undervalued considering the potential currently in the development pipeline. Both could launch multiple blockbuster drugs in 2017, which would boost earnings and help dispel the negative sentiment that plagued both groups last year. We also like animal medicine company Dechra Pharmaceuticals (DEC), which now boasts excellent growth opportunities, having recently acquired three new businesses. Although that stretched net debt to a ratio of two times adjusted cash profit – the upper limit previously communicated to shareholders – underlying cash generation remains strong and the integration of the business is progressing well.

Outsiders: Addiction specialist Indivior (INDV) had a better year than expected after a patent dispute turned in its favour and a final-phase clinical trial reported a positive outcome. But we’re still on the fence as further legal disputes remain to be resolved, while the new drug won’t be launched until the end of 2017 at the earliest.