by winston » Tue Apr 11, 2017 2:53 pm
Sarah Ketterer
Chief executive officer and fund manager, Causeway Capital Management
Buy the Pharma Discount
Why do several of the large global pharmaceutical stocks trade at above-market dividend yields and below-market price/earnings ratios? Perhaps the repeated threats by President Trump to cut drug prices have scared investors.
The president will likely claim victory for something that is already happening. The large buyers of U.S. pharmaceuticals, such as pharmacy benefit managers and health insurers, continue to exert tremendous pressure on drug companies to discount prices.
This is evident in 2016 data from Express Scripts that show year-on-year price percentage shrinkage in traditional pharmaceuticals and a slowing, mid-single-digit percentage increase for specialty drugs.
Importantly, utilization growth rates are greater than unit cost rises, indicating product efficacy. If the drugs weren't effective, doctors wouldn't prescribe them. Assuming buyers will pay for efficacious drugs, then the prognosis for the more innovative pharmaceutical companies is good.
Notably, several of the European drug giants with promising pipelines trade at valuation discounts to the health-care sector and to their own historical averages. Examples include Novartis AG, AstraZeneca Plc, Roche Holding AG and GlaxoSmithKline Plc.
These well-managed, shareholder-friendly companies generate plenty of surplus cash to reward investors. Many of them have dividend yields at least a full percentage point in excess of the global pharmaceutical and biotech industry and well above overall equity market averages.
Famously profitable, the best-managed pharmaceutical companies should be able to offset reduced unit prices with volume growth. In their report dated January 2017, Evercore ISI analysts Umer Raffat and Akash Tewari note that most of Medicare/Medicaid spending increases are due to higher enrollment, not because of pharmaceutical costs.
While total U.S. health-care spending continues to increase, the percentage attributable to prescription drugs has stayed flat, at around 10 percent.
Proposed drug pricing reforms, such as bidding, reimportation, Medicare negotiating prices and value-based pricing either already exist or have serious, likely insurmountable flaws, such as public safety.
Even Medicare, the colossus of U.S. pharmaceutical buyers, probably can't negotiate prices more favorable than under current law without being forced to restrict access, as drug demand may rise.
Aging demographics imply increased drug usage over at least the next decade. The most innovative pharmaceutical companies will likely benefit, even as traditional branded drug prices fade.
Ways to play it with ETFs: The SPDR S&P International Health Care Sector ETF (IRY) has the most exposure of any ETF to international pharma companies such as Novartis AG and AstraZeneca Plc.
Those companies are in the top 10 holdings. The ETF has 75 percent allocated to pharma companies, 25 percent of which are based in Switzerland. IRY comes with a fee of 0.40 percent.
Source: Bloomberg
It's all about "how much you made when you were right" & "how little you lost when you were wrong"
