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The pharmaceutical sector has been slowly but steadily recovering from the impact of the patent cliff being faced by several companies over the past few years. The worst of the patent cliff is over and the NYSE ARCA Pharmaceutical Index (^DRG) is up 21.4% over the last year. So far in 2014, the index is up 6.9%.

Several companies which had been struggling to post growth in the face of genericization over the past few years are now on the recovery path. New products should start contributing significantly to results, and increased pipeline visibility and appropriate utilization of cash should increase confidence in the sector.

Products that lost exclusivity recently include Eli Lilly’s (LLY) Cymbalta and Evista. AstraZeneca’s (AZN) Nexium could also start facing generics from May 2014 in the U.S. where sales were $2.1 billion in 2013.

Collaborations, Acquisitions and Restructuring

The pharma sector witnessed major merger and acquisitions (M&A) activity over the last couple of years. Going forward, we expect small bolt-on acquisitions to continue. In-licensing activities and collaborations for the development of pipeline candidates have also increased significantly. 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 in-licensing activities and collaborations. Most of these companies find it challenging to raise cash, thereby making it difficult for them to survive and continue with the development of promising pipeline candidates. Therefore, it makes sense for them to seek deals with pharma companies that are sitting on huge piles of cash.

We recommend biotech stocks that have attractive pipeline candidates or technology that can be used for the development of novel therapeutics. Therapeutic areas which could see a lot of in-licensing activity include immuno-oncology, oncology, central nervous system disorders, diabetes and immunology/inflammation. The hepatitis C virus (HCV) market is also attracting a lot of attention.

Some recent acquisitions/deals include Shire’s (SHPG) acquisition of ViroPharma, Salix’s (SLXP) acquisition of Santarus as well as the acquisition of Optimer Pharmaceuticals and Trius Therapeutics by Cubist Pharmaceuticals (CBST) and that of Elan by Perrigo Company (PRGO - Free Report) . A major acquisition agreement was announced recently -- that of Forest Labs (FRX) by Actavis (ACT). This deal shows the intention of generic companies to establish a strong position in the branded market. Another significant deal was the one signed between Celgene (CELG) and OncoMed Pharmaceuticals (OMED - Free Report) for the joint development and commercialization of up to six anti-cancer stem cell candidates from OncoMed's biologics pipeline.

Another trend that we are seeing in recent months is the divestment of non-core business segments. Pfizer (PFE - Free Report) sold its Capsugel unit and its Nutrition business in Aug 2011 and Nov 2012, respectively. Pfizer then spun off its animal health business into a new company, Zoetis (ZTS - Free Report) .

Meanwhile, GlaxoSmithKline (GSK) divested certain non-core brands from its Consumer Healthcare segment. In Aug 2011, AstraZeneca sold its Astra Tech business to DENTSPLY (XRAY - Free Report) . The monetization of non-core assets will allow the pharma/biotech companies to focus on their areas of expertise. Abbott Labs (ABT) split into two separate publicly traded companies; while one company deals in diversified medical products, the other, AbbVie (ABBV), is focusing on research-based pharmaceuticals. Johnson & Johnson (JNJ) is also looking to divest its ortho-clinical diagnostics business. Vertex (VRTX - Free Report) monetized its Incivo-related royalties; the company can use the cash generated from this deal for its cystic fibrosis program.

Restructuring activities are also gaining momentum as large pharma companies are looking to cut costs and streamline their operations. Most of these companies are re-evaluating their pipelines and discontinuing programs which do not have a favorable risk-benefit profile. Some of the companies that announced restructuring plans include Merck (MRK - Free Report) , Novartis (NVS - Free Report) , Eli Lilly, Shire and Sanofi (SNY - Free Report) .

Destination Ireland

Of late, several companies have been looking towards Ireland for acquisitions. The latest company to join the Irish club is Horizon Pharma (HZNP) which is doing a reverse merger with Dublin-based Vidara. Tax benefits are a major attraction for such deals. Other such recent acquisitions include that of Warner Chilcott by Actavis and Elan by Perrigo.

Emerging Markets and Biosimilars

Another trend seen in the pharmaceutical sector is a focus on emerging markets. Companies like Mylan (MYL - Free Report) , Pfizer, Merck, Eli Lilly, Glaxo and Sanofi are all looking to expand their presence in India, China, Brazil and other emerging markets.

Until recently, most of the commercialization efforts were focused on the U.S. -- the largest pharmaceutical market -- along with Europe and Japan. Emerging markets are slowly and steadily gaining more importance, and several companies are now shifting their focus to these areas.

However, while higher demand for medicines, government initiatives for healthcare, new patient population and increasing use of generics should help drive demand, we point out that emerging markets are also not immune to genericization. Moreover, investigations into bribery charges in China could put a lid on near-term growth.

Meanwhile, growth in Europe will continue to be pressurized by austerity and cost-containment measures.

We are also seeing several companies entering into deals for the development of biosimilars, generic versions of biologics. Companies like Merck, Amgen, Biogen (BIIB) and Actavis are all targeting the highly lucrative biosimilars market.

4Q Earnings

All companies falling under the Medical sector have reported fourth quarter and full year 2013 results. While earnings-beat and revenue-beat ratios (percentage of companies coming out with positive surprises) were pretty impressive, growth ratios were modest. Fourth quarter results were characterized by currency headwinds as well as the impact of generics.

Fourth quarter 2013 earnings "beat ratio" was 74.0% while the revenue "beat ratio" was 76.0%. Total earnings for this sector were up 1.1%, compared to 0.2% recorded in the third quarter of 2013. Total revenues moved up 5.3% in the quarter versus 5.8% growth in the third quarter of 2013.

Looking at the consensus earnings expectations for the first quarter, earnings are expected to decline 3.3%. Tough challenges for some companies, negative currency movement and a few patent expirees will affect first quarter growth. However, growth should pick up from the second quarter for which 1.6% earnings growth is expected.

Overall, 2014 earnings are expected to grow 6.5%. For a detailed look at the earnings outlook for the Medical and other sectors, please check our Zacks Earnings Trends report.

Focus on New Products

2013 saw the FDA approving 27 novel medicines, about one-third (33%) of which were identified by the FDA as “First-in-Class,” meaning they use a new and unique mechanism of action for treating a medical condition. These include drugs like Invokana (type II diabetes), Kadcyla (HER2-positive late-stage breast cancer), Sovaldi (an interferon-free oral treatment for some patients with chronic hepatitis C) and Mekinist (metastatic melanoma).

Yet another one-third of the approved drugs fall under the rare or “orphan” disease category that affects 200,000 or fewer Americans. These include Imbruvica (mantle cell lymphoma), Gazyva (chronic lymphocytic leukemia), Kynamro (homozygous familial hypercholesterolemia) and Adempas and Opsumit (both for pulmonary arterial hypertension). Three of the approved drugs – Gazyva, Imbruvica and Sovaldi – had breakthrough therapy designation. Breakthrough status, a new designation that became effective after Jul 9, 2012, is designed to cut short the development time of promising new treatments.

Some important products approved in 2013 include:

Drugs like Tecfidera, Sovaldi and Imbruvica represent strong commercial potential.

So far in 2014, drugs that have gained approval include AstraZeneca’s Myalept (complications of leptin deficiency) and Farxiga (type II diabetes), Chelsea Therapeutics’ (CHTP) Northera (to treat neurogenic orthostatic hypotension), BioMarin’s (BMRN) Vimizim (Morquio A syndrome) and Vanda Pharma’s (VNDA - Free Report) Hetlioz (non-24- hour sleep-wake disorder).

Upcoming events include FDA advisory panel review of the regulatory application for MannKind’s (MNKD) experimental diabetes treatment, Afrezza. April should be an active month with the agency expected to deliver a response on the approvability of several experimental drugs including Afrezza, Glaxo’s Eperzan (type II diabetes) and Arzerra (CLL).

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. To learn more, visit: About Zacks Industry Rank.

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 pharma is #225, med-biomed/gene is #69, med-drugs is #84, while the med-generic drugs is #8. Analyzing the Zacks Industry Rank for different medical segments, it is obvious that the outlook is Positive for med-drugs, med-biomed/gene and med-generic drugs and Negative for large-cap pharma stocks.


While several companies will continue to face challenges like EU austerity measures and genericization, the pharma industry is out of the worst of its genericization phase. Many companies which had faced generic headwinds in the last couple of years should continue to see a sustained improvement in results this year. Cost-cutting, downsizing, streamlining of the pipeline, growth in emerging markets and new product launches should support growth.

Among pharma stocks, Shire, a Zacks Rank #1 (Strong Buy) stock, looks well-positioned for growth with the company expanding its product portfolio and pipeline through the acquisition of ViroPharma. Horizon Pharma, a Zacks Rank #2 (Buy) stock, also seems on the right path with the company announcing its plans to acquire Ireland-based Vidara.

In the biotech space, we are positive on Biogen. Tecfidera, the company’s recently launched oral multiple sclerosis drug, is off to a strong start with the product delivering sales of $876 million (as of Dec 31, 2013) since its launch in early April 2013. While Tecfidera has gained the top spot in the oral multiple sclerosis market in the U.S., Avonex and Tysabri should continue contributing significantly to sales. Tecfidera gained EU approval recently. Biogen is also progressing with its hemophilia pipeline.

We are also positive on Amgen (AMGN). Amgen should be able to deliver on its long-term strategy based on expansion in key markets, launch of new manufacturing technologies, and pipeline development. Enbrel should continue performing well. Amgen’s late-stage pipeline is also moving along. While Amgen is a Zacks Rank #2 stock, Biogen is a Zacks Rank #3 (Hold) stock.

Gilead, a Zacks Rank #1 stock, continues to do well in the HIV segment and has a potential blockbuster in its portfolio in the form of HCV treatment, Sovaldi.

Among generic companies, Actavis looks well-positioned. Actavis is slowly and steadily building its position in the branded market through acquisitions (Actavis Group, Warner Chilcott and the upcoming acquisition of Forest). With fewer major patent expiries slated to occur in the next few years, we are encouraged by Actavis’ focus on building its branded and biosimilars pipeline. The company carries a Zacks Rank #2.


We recommend avoiding names that offer little growth or opportunity for a take-out. These include companies which are developing drugs that are likely to face regulatory hurdles.

Among large-cap pharma companies, Eli Lilly is gearing up for another round of patent expiries -- Cymbalta in Dec 2013 and Evista this year. We prefer waiting on the sidelines until the company is able to emerge from the impact of genericization.  

Companies that currently carry a Zacks Rank #4 (Sell) include Bayer (BAYRY), Sanofi and Glaxo among others. Sanofi, which is facing currency headwinds, was in the news recently related to the development of its PCSK9 inhibitor, alirocumab. The FDA has asked Sanofi and partner Regeneron (REGN - Free Report) to evaluate potential neurocognitive adverse events across the global development program for alirocumab, especially in long-term studies. While results on PCSK9 inhibitors in development have been encouraging so far, this is the first time that serious safety concerns have been raised.

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