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Health Care

Pfizer Set to Stun

By Yiannis G. Mostrous, on May. 20, 2014

Investors have long regarded Pfizer (NYSE: PFE) as defensive plays based on the assumption that consumers will continue to spend on medications and other health-related products when the economy weakens.

Although shares of big pharmaceutical companies have earned a reputation for resilience, recent developments suggest that some names offer investors an overlooked growth element.

The New Innovation in Pharmaceuticals: Biologics

Biological medical products, or biologics, differ from traditional pharmaceuticals in that they are produced biologically and can comprise a combination sugars, proteins and nucleic acids. In some instances, biologics may consist of cells, tissues and other living entities. 

Cutting-edge biotechnologies enable pharmaceutical companies to isolate these biological treatments from a variety of natural sources, from humans and animals to microorganisms.

Whereas chemically synthesized drugs exhibit an identifiable structure, the complexity of many biological products defy easy definition.

These innovative treatments represent the cutting-edge of biomedical research and eventually may emerge as the most effective means to remedy a variety of medical illnesses and conditions for which no cures exist.

Equally important, biological treatments are more difficult to replicate than chemically synthesized drugs, proving a degree of insulation against competition from generic versions when the patents expire.

With their bulletproof balance sheets, the biggest pharmaceutical names remain best-positioned to commercialize biological products.

Medicating America

With relatively low per capital spending on health care and growing household incomes, emerging markets represent an important part of the pharmaceutical industry’s long-term growth story.

The biggest pharmaceutical companies have a global footprint, but the US still accounts for about 35 percent of their sales.

And for investors who doubt the US dollar’s strength, rumors of the greenback’s death have been greatly exaggerated. We expect the greenback to appreciate relative to the euro and other currencies as the domestic economy picks up steam and a new morning in America takes hold.

And the US Food and Drug Administration (FDA) hasn’t slowed the approval of new molecular entities (NME), novel biologics and chemically synthesized drugs containing active ingredients that the FDA hasn’t previously approved. NMEs often treat previously unmet medical needs or promise to advance patient care and public health significantly.

 

The FDA’s steady approval of NMEs highlights the amount of innovation under way in the pharmaceutical space.

Investors who worry that the implementation of the Affordable Care Act will take a bite out of Big Pharma’s profits should take their medicine. Insurance companies traditionally have focused on mass rebates, as opposed to drug pricing. Moreover, drug prices represent only 12 percent of US health care costs; payments to doctors account for a much higher percentage.

Valuations

Shares of the biggest pharmaceutical companies command valuations that are a far cry from the multiples achieved 1990s, when these stocks were all the rage.

Although investors shouldn’t expect the industry heavyweights to return to these heady valuations, the group has traversed the worst of the patent expiration cliff that has scared off investors in recent years.

And these names fetch lower multiples than high-flying companies that specialize in producing generic drugs for emerging markets.

Big Pharma stocks have enjoyed quite a run in recent months. But the emergence of sophisticated new treatments suggests that the group could deliver more growth than expected, while providing the stability that investors prize during periods of market turbulence.

Our Top Pick: Pfizer

 

With annual sales of more than $50 billion, Pfizer is one of the world’s largest pharmaceutical companies and stands to benefit from restructuring efforts and its promising oncology unit.

The company will split its commercial operations into three segments for 2014:

  • Innovation 1, which will house a wide range of treatments that boast patents that extend beyond 2015;
  • Innovation 2, which will include Pfizer’s vaccines, oncology and consumer assets, each of which will operate as a distinct business;  and
  • The Value Segment, which will include off-patent medicines and drugs whose patents will expire through 2015.

Many analysts expect this reorganization to mark the first step in the potential spinoff of the value segment.

 

Pfizer’s oncology business generated $2 billion in revenue last year and should drive the company’s future earnings growth, beginning with the launch of a promising breast cancer treatment in 2015.

The pharmaceutical giant has actively repurchased its stock over the past 12 months, reducing its float by more than 11 percent. We expect management to continue to follow this course while the company’s shares trade at a discount to its peers.

Yiannis G. Mostrous contributes his expertise in emerging markets and international equities to Capitalist Times in his Global Top Cat columns.

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