There is no doubt that 2016 was a tough year for pharma and biotech stocks, with the sector facing a lot of criticism for rising drug prices. Although shares did rally post-election in November on hopes that drug pricing would not be a key focus area under a Trump presidency, the rally turned out to be short-lived following the President’s views regarding drug pricing. Trump made it clear that he does not like what happened to drug prices and he will bring them down.
Not just drug pricing, 2016 was also disappointing from an R&D perspective with a fewer number drugs managing to gain FDA approval. There were some high-profile pipeline failures as well. Other factors that weighed on the sector include mixed results, slower-than-expected new product launches and increasing competition.
The impact of these issues resulted in the NASDAQ Biotechnology Index declining 19.1% in 2016 while the NYSE ARCA Pharmaceutical Index fell 9.7%.
Is the Sector Set for a Rebound in 2017?
So far in 2017,the sector is showing signs of recovery with the NYSE ARCA Pharmaceutical Index gaining 5.1% while the NASDAQ Biotechnology Index is up 7.3%. New product sales ramp up, R&D success and innovation, strong results, FDA approvals and continued strong performance from legacy products are some of the factors that could contribute to a sustained recovery in the sector. Tax reforms as well as cash repatriation would support a recovery as well.
Valuation Looks Slightly Stretched
Going by the current price-to-earnings multiple, which is often used to value drug stocks, the pharmaceutical industry doesn’t look attractive at this point. The industry is currently trading at a P/E multiple of 18.69 which is close to the S&P 500 P/E multiple of 18.71. Moreover, when compared to the industry’s own performance over the last year, it can be seen that the multiple is close to the industry high of 20.01. So investors might not be keen to pay more premium to invest in this industry.
Drug Pricing Will Remain a Concern
Drug pricing, which was a key source of concern last year, will remain a headline risk in 2017 as well. Right now, there is low visibility on how this issue will play out. While it is clear that the government intends to address the drug pricing issue, there is no clarity on what steps will be taken.
Will M&As Pick Pace in 2017?
While there were not too many acquisitions in 2016, expectations are that M&A activities will pick up this year. So far in 2017, there has been limited M&A activity with Johnson & Johnson (JNJ - Free Report) announcing its intention to acquire Actelion for $30 billion and a few bolt-on deals being announced by other companies. However, expectations are high that M&As will increase as the year progresses -- potential tax reform and cash repatriation are expected to lead to a boost in this area.
Several pharma companies are focusing on in-licensing mid-to-late stage pipeline candidates that look promising, instead of developing a product from scratch, which involves a lot of funds and time. Small biotech companies are open to such deals, with most of them finding it challenging to raise cash, thereby making it difficult to survive and continue with the development of promising pipeline candidates. Therefore, it makes sense to seek deals with pharma companies sitting on huge piles of cash.
Divestment of Non-Core Assets & Restructuring Activities
Another trend being witnessed is the divestment of non-core business segments. Companies like Pfizer (PFE - Free Report) , UCB, Novartis, Sanofi, Valeant, Glaxo (GSK - Free Report) and AstraZeneca have all been a part of this trend. The monetization of non-core assets allows these companies to focus on their areas of expertise.
Restructuring activities are also gaining momentum as large pharma companies look to cut costs and streamline operations. Most of these companies are re-evaluating their pipelines and discontinuing programs with an unfavorable risk-benefit profile.
New Products Should Gain Traction
Highly-awaited new products that gained approval over the last couple of years should contribute significantly to revenues. Key new products include Ibrance (cancer), Cosentyx (psoriasis), PCSK9 inhibitors – Repatha and Praluent, Cotellic (advanced melanoma), Lartruvo (soft tissue carcinoma), Exondys 51 (Duchenne muscular dystrophy), Tecentriq (urothelial cancer), and Taltz (moderate-to-severe plaque psoriasis), among others. The FDA also expanded the label of cancer drugs like Kyprolis, Imbruvica and Xalkori.
Biosimilars Gaining Importance
With the FDA approving the first biosimilar in the U.S. (Zarxio, a biosimilar version of Amgen’s (AMGN - Free Report) blockbuster drug, Neupogen), the floodgates have opened. While biosimilars have been available in the EU for quite a while, there was no regulatory pathway for biosimilars in the U.S. The second biosimilar to gain approval in the U.S. was Pfizer and Celltrion’s Inflectra (infliximab-dyyb) with the reference product being Remicade.
This was followed by the FDA approval of biotech giant Amgen’s Amjevita (adalimumab-atto). Amjevita is approved for use in all eligible indications of the reference product, AbbVie Humira (adalimumab), which is used for a wide range of inflammatory diseases.
And then there is Lilly (LLY - Free Report) and Boehringer Ingelheim’s Basaglar, which while technically not approved as a biosimilar, is a “follow-on” insulin glargine product approved through an abbreviated approval pathway -- Basaglar was found to be sufficiently similar to Sanofi’s Lantus to scientifically justify reliance, and to establish its safety and efficacy for the approved uses.
Biosimilars should cut healthcare costs and provide a large number of patients with access to much needed biologic treatments. According to information provided by Express Scripts, about $250 billion could be saved in the next decade (2014 – 2024) if biosimilars for 11 products including Neupogen, Avastin, Epogen, Humira, Neulasta, Remicade and Rituxan are approved. According to the company, Neupogen biosimilars alone represent potential savings of about $5.7 billion.
Apart from Novartis and Pfizer, companies like Merck (MRK - Free Report) , Amgen, Biogen and Allergan AGN are targeting the highly lucrative biosimilars market. While all these companies are Zacks Rank #3 (Hold) stocks, you can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
How Did the Sector Fare in Q4 Earnings Season?
As of Feb 17, 2017, 83.3% of the Medical sector had reported results with earnings growing 4.8% on revenue growth of 5.3% from the year-ago period. While the earnings beat ratio was 80%, the revenue beat ratio was 53.3%. Medical is one of the standout sectors among the 16 Zacks sectors.
Meanwhile, a look at consensus earnings expectations from the Zacks Earnings Trends report shows that the Medical sector will deliver earnings growth of 5.5% and revenue growth of 5.4% in 2017.
While new products should start contributing significantly and increased pipeline visibility and appropriate utilization of cash should increase confidence in the sector, challenges remain in the form of currency headwinds, additional competition, slowdown in growth of mature products and loss of exclusivity for certain key drugs.
Zacks Industry Rank
Within the Zacks Industry classification, pharma and biotech are broadly grouped into the Medical sector (one of 16 Zacks sectors) and further sub-divided into four industries at the expanded level: large-cap pharma, med-biomed/gene, med-drugs and med-generic drugs.
We rank all the 260-plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry.
As a point of reference, the outlook for industries with Zacks Industry Rank #88 and lower is ‘Positive,’ between #89 and #176 is ‘Neutral’ and #177 and higher is ‘Negative.’
The Zacks Industry Rank for Large-Cap Pharmaceuticals is #169, #196 for Medical-Generic Drugs, #156 for Medical-Biomedical and Genetics and #103 for Medical-Drugs. Analyzing the Zacks Industry Rank for different medical segments, it is obvious that the outlook is Neutral for Large-Cap Pharmaceuticals, Medical-Drugs and Medical-Biomedical and Genetics while Negative for Medical-Generic Drugs.
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