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UK pharma in need of a tonic

The UK’s three pharma giants have not given investors much cause for celebration in recent months and the outlook isn’t particularly encouraging
April 27, 2018

It’s tough to be a British investor with a penchant for big pharma. Since Hikma (HIK) took a dive in 2016, there are just three drugs companies left in the FTSE 100 and none of them is giving much cause for celebration. GlaxoSmithKline (GSK) and Shire (SHP) have both underperformed the benchmark in the last 12 months, while AstraZeneca (AZN) has morphed into a high-risk biotech stock, with a worrying reliance on positive clinical trial data. No longer a comfortable haven, bolstered by revenue visibility, whopping margins and generous dividends, big pharma in the UK has become a risky sector which is testing investor patience.

First-quarter results from the largest of the trio – GSK – will have done little to ease concerns. Currency headwinds sent reported revenues down 2 per cent, while falling sales from the two top respiratory drugs stunted like-for-like revenue growth in the pharmaceutical division. Management may be singing the praises of new medicines Shingrix, Trelegy and Juluca, but these failed to make up for dwindling demand for older products.

Investors seeking reassurance should look to the balance sheet, which is in better shape than it was this time last year. In March, GSK bought Novartis’s minority stake in the companies' consumer healthcare joint venture, which removed an £8.6bn liability from the balance sheet and “a long-term uncertainty for the group's capital planning”, according to chief executive Emma Walmsley. This may be true, but the dividend is still not looking particularly solid. Free cash flow – to which the payout is linked – fell 50 per cent to £324m in the first quarter.

At Shire, strength in the immunology, haematology, and ophthalmic businesses helped lift revenues and earnings above expectations in the first quarter, but these decent numbers pale in comparison to the takeover palaver currently facing investors.

Japanese group Takeda has offered cash and shares which values the company at roughly £49 per share (dependant on Takeda’s share price which has been in free fall since making its bid). Approval of the acquisition would land shareholders with 50 per cent of a combined entity, which is expected to come with a net debt to adjusted cash profits ratio of 4.2 times and very few potential synergies. But if the deal falls through, Shire’s share price – which is up 31 per cent since Takeda first mooted its interest – is certain to collapse. By holding on, investors are waiting on a rival offer, ideally of the cash variety.

Then there is Astra whose first-quarter numbers don’t come out until mid-May, but will be relatively unimportant compared with any drug development updates. Clinical updates on four separate cancer drugs in April alone prove the depth in Astra’s drugs pipeline, but the forecast decline in 2018 revenues and profits (which will no doubt be highlighted when Astra releases its numbers) demonstrates how reliant the group is on new medicines.  

And even if Britain’s three pharma heavyweights manage to solve their respective corporate conundrums, they’re facing a market under immense pressure. In 2017, US spending on drugs increased 1.4 per cent, compared with a 4.8 per cent rise the previous year – a telling indication that pharmaceutical spending is starting to moderate after years of above-inflation growth.

Meanwhile, pharma companies are facing the threat of new regulation on the price of their drugs. Although executives argue that the high price of branded drugs is necessary to fund life-changing research and development, the recent launch of a $850,000 (£616,925) blindness remedy or the $457,000 medicine that can cure young leukaemia patients, looks excessive. Lower drugs prices would have a detrimental effect on margins and thus the returns available to company investors.