Investing in Pharma: Europe vs the US

14th September 2012

The pharmaceutical sector has endured a torrid decade across several fronts – patent expirations, anaemic pipelines, pricing and political pressure. The sector enjoyed great success in the last two decades of the twentieth century, when burgeoning pipelines were bringing blockbuster drugs to the market with remarkable frequency, at 90%+ margins. Drugs like Prozac and Viagra have come to define an era, when cash flows generated by the sector in the 1990s, in particular, rivalled the tobacco sector.

During the first decade of the current century, the sector has been largely unloved and frequently ignored, no longer seen as a growth sector, with many rushing to write its obituary. These years led so called "big pharma" to turn to M&A to protect market share and prop up the diminishing R&D returns – $500bn spent since 1980 on 50 deals.[1] Several household names – American Home Products, Hoechst, Pharmacia, Beecham, Warner-Lambert – disappeared during this time, when company management spent hundreds of billions on buying up rivals at inflated prices, further compounded by overpaying for early stage biotech assets, which often added little or nothing to the bottom line in the long run. The top 10 companies account for nearly 50% of the global pharmaceutical market.

The sector has become more in vogue during the financial crisis, with its defensive characteristics coming to the fore. The larger players have maintained healthy balance sheets, with little leverage, high cash generation, and a growing dividend stream, all of which is being offered on a relatively cheap valuation.   The long term drivers augur well for the sector, with an increasing and ageing population, underpinned by a burgeoning middle class in emerging markets who are developing lifestyle disorders such as obesity, diabetes and cardiac diseases.

The re-rating of the sector has produced clear geographical winners and losers, with the US large cap players outperforming over the past three years. However, looking ahead, the European large cap companies are better positioned. They have a smaller patent cliff, greater revenue diversification via consumer, healthcare and biotech assets, and a larger presence in emerging markets. This bias plays out in terms of sales and margin growth. In terms of valuation, European large cap companies are on average cheaper, offering a higher level of dividends, both in term of yield and growth. For example, Roche has delivered dividend growth of 15% per annum over the past 5 years.

The US companies still offer compelling value in the American market, offering yield of nearly 4%, solid balance sheets and good cash flow generation, but from a global perspective, the European companies are well positioned to offer better value in the medium to long-term. The greater level of diversification, fuller pipelines, more robust balance sheets and greater exposure to the fast growing emerging markets should lead to a greater competitive advantage.

 

More from Ketan Patel:

Singapore – The business capital of the world?

ESG – Absent in Asia

Norway – Safe haven in Europe!

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30 thoughts on “Investing in Pharma: Europe vs the US”

  1. Neil says:

    Limiting a Chief Execs pay to a muliplier of average pay for employees in said company would be worth a shout !! CEO wants a pay rise, he needs to improve his employees average pay first.
    Would that work??

    1. Anonymous says:

      I doubt it. CEO creates an extra company and outsources the labour to it, the original company then only consists of a few execs and the average pay multiplier is subverted.

      Make the execs accountable to the shareholders in private businesses and accountable to the voters in the public sector. Any citizen ought to be able to request a referendum on for example “Limiting the local council chief’s salary to £80,000” and a simple majority of voters can choose to reject a council leader’s 250K salary.

    2. Anonymous says:

      Hi Neil and welcome to my part of the blogosphere

      I can see that Expat has already replied but would add that in my opinion we need to reinstate shareholders authority over the company. Somewhere on the journey to remuneration committees and the like shareholders lost control and directors in effect set their own terms.

      1. James says:

        The trouble is (and I have sat on many of these committees):

        1. All consultants know that they won’t get reappointed if they don’t recommend rises;

        2. You have executives keen on pay and with full-time resources to devote to the issue, whereas non-execs are just part-timers

        3. High executive pay rarely comes back to haunt non-execs

        4. Once the comparative game starts, everyone thinks that, because they are exceptional talent, they deserve upper quartile rewards
        One thing that I would say, however, in favour of high CEO pay is that ludicsrous city pay is a much greater problem. First, it isn’t public in general. Secondly, it is draining off talent from useful bits of the economy.
        I tell you that I’d much rather anonymously pick up my millions in the city than pick up less as a publicly harassed CEO.

        1. Anonymous says:

          Love point 1. That’s exactly the kind of realpolitic that utterly escapes somewhere like FTAlphaville who would start banging on about free markets being efficient!

  2. anteos says:

    great article as always Shaun.

    I would argue that the impact of inflation has been worse.If we look at the research by tullet prebon:

    http://ftalphaville.ft.com/2013/02/20/1393672/the-real-rate-of-british-inflation/

    Not that it would bother merv with his massive RPI index linked gold plated pension, underwritten by the very people he was robbed.

    1. Anonymous says:

      Hi Anteos

      Thanks for the link which is interesting. As you know inflation (miss)measurement is one of my interests and themes.

  3. James says:

    Shaun,
    very interesting as ever.
    One thing that must be wrong in the TUC figures is the statistic quoted about CEOs earning 145 times more than the average wage. If you take the average wage as, say, £25,000, that would make the CEO on £3.6 million. Perhaps they meant FTSE 100 CEOs.
    I dont know of any CEOs outside the FTSE earning anything like that.

    1. Anonymous says:

      Hi James

      I am sure that you are right about that and the TUC should have made it clearer what they meant as otherwise it might mislead.

  4. Anonymous says:

    Does nobody here ever fundamentally question the capitalist system? Or is it a quasi religion, never to be questioned? Loads of the usual excuses, no doubt, just like for the Soviet model, but that failed in the end. The free market (so-called) has evidently failed too. What next?

    1. James says:

      A very good question, but rather hard to see what else can deliver:
      1. Rising wealth
      2. Welfare on the scale expected by western voters.
      I spent some time in the Soviet Union before perestroika and can tell you that it had:
      1. Most of the excesses of the west (privilege for the few etc, just the political not financial elite)
      2. Not much wealth to spread around anyway
      3. A very unpleasant centralised state machinery deciding everything.
      I would phrase the question slightly more in terms of how do we get capitalism to deliver for the majority not the minority ( I have no answer btw)

      1. Anonymous says:

        Surely no system can deliver rising wealth for everyone, given that we live on a finite planet? Maybe the growth model has hit the buffers. Do economics courses include any reference to the exponential function, I wonder?

        1. Neil says:

          Hi Abune,

          I can attested that during my MBA courses I had to swallow some economics and can tell you that the exponential function was largely ignored. However how many are aware of it regardless of understanding it?

          To quote Isaac Asimov

          Democracy cannot survive overpopulation, as you put more and more people into the world, the values of life not only decline, it disappears. It doesn’t matter, if someone dies, the more people there are, the less one individual matters. We must recognise that population growth is the immediate cause of all our resources and environmental crisis.

          And Dr. Albert Barlett

          You cannot sustain population growth and you cannot sustain growth in the rate of consumption of resources in a finite resourced world….it is not debatable!

          Based on those two quotes, you can have some insights to where we are heading… toward change,
          the only constant in life… Civilisations, societies, systems, ideas etc… rising and dying… always been that way!

          And still posting as Neil ??? (sorry Neil) Here is Justathought

          1. Kev says:

            The planet is finite, but the universe is infinite. Spreading human life through the universe may appear fanciful, but the alternative is a cull.

    2. Neil says:

      Hi Abune,

      The capitalist system never existed always has been a mixed
      system, the so called free market and free enterprise (SME) is long dead submersed by regulations, red tapes taxations and the ever failing schooling system (producing slightly instructed and robotised people but no educated people with at least an ounce of critical thinking). This 19th century frame of references (Capitalism, communism etc…) is no longer sustainable but with debts.
      Gratefully our unemployed youth are waking up to the reality of the system imposed unto them by their elders. (The elders voted for this system while the youth could not vote).To quote one of the youth reflexion lately overheard… Why should we move a finger…Let’s the elderly who lead us into this mess…make the revolution for themselves…
      Here is Justathought, I do not know why I am ending up posting as Neil ???

      1. Anonymous says:

        I think your point about the current system only being sustainable by debt gets to the heart of it. How can a system based on debt be sustainable? It seems to me to be mathematically impossible. Can all the debt in the world ever be repaid? And if it can’t (which seems to me to be obvious) then can the solution be yet more debt? Again, to me, the answer seems obvious, but the political class, of all available flavours, offer only that solution. Which is worrying in terms of democracy, never mind economics.

        1. James says:

          If you look at a long historical perspective, it IS unsustainable to live off debt. History provides several different responses:

          1. Default. Used many many times from Spain refusing to pay back (Jewish) lenders in the sixteenth century, to Greece (three times, I think) to post-revolution France, Russia etc

          2. You invade someone else and steal their money. Latest example A Hitler who ran up huge deficits building those nice autobahns

          3. Currency collapse. Many examples, including Germany in the 20s (although this was external debt rather than deficits)

          To modern politicians, who have the added irritation of pretending to listen to voters every few years, these probably seem a little extreme, so we go round and round doing anything to avoid the spinning plates stopping, including QE, longer and longer dated gilts, etc etc.

    3. Anonymous says:

      Hi Abune,

      I agree with James that the capitalist system is a better option than all the others we’ve tried. It’s not perfect but I’d try to fix it’s flaws through evolution, not revolution.

      Decent effective regulation helps the people – monopolies, cartels and chicanery ought to be punishable and mostly prevented in a fair market.

      Certainly the UK’s light touch regulation is a complete failure, with offending bankers receiving a slap with a wet bus ticket for LIBOR fraud. I’d suggest jail and asset recovery as more appropriate punishment.

      1. Patrick says:

        …but regulation is supposedly what prevents ‘true’ capitalism from working…

        Is there a type of regulation that free market capitalism can exist with, or are the two things mutually exclusive. If they’re mutually exclusive, then don’t we have to assume that Capitalism just cannot work?

        It often seems that when real world capitalism gets critiqued, it immediately turns into a political, rather than economic argument, linking supposedly intrinsic left centric policy to its failings.

        Seems to me that basic corporate laws have a much bigger part to play in the failings of contemporary capitalism. Both in terms of corporate entity rights, and the enforced pursuit of profit at any/all costs.

        1. Anonymous says:

          I know we get lots of “free market deregulation” hype from lobbyists and the mainstream press. We get bank bosses complaining about cost of implementing new laws. It’s media hype.

          Britain has acquired a checkbox culture, where many silly rules are codified and complied with but they cannot cover everything dubious.

          An alternative has a lightweight regulatory code with the emphasis complying with the spirit of the law. Eg, we expect you to behave ethically and will take action if we feel you are not.

          Rules and order are needed – good roads and honest traffic police both save lives and make travel quicker. German shareholders appear better rewarded and protected than English shareholders – English regulation allows company directors to overpay themselves while losing money. I might ask if German businesses are reaping a benefit of treating shareholders fairly ….

          1. Kev says:

            The Data Protection act is an excellent example of this. Much blamed by incompetent investigators and the like, all you have to do to side step it is to include the relevant caveat in your terms and conditions.

    4. Anonymous says:

      Hi Abune and welcome to my part of the blogosphere.

      I see you already have some replies but we have pretty much concluded on here in the past that we have had crony capitalism which has elements of a feudal structure about it. The real question in my opinion is does human nature always push us that way?

      1. Patrick says:

        A system based entirely on ‘self’ interest was only ever going to result in croney capitalism, as those who gain an advantage, do everything in their power, sometime outside of the law to protect what they have. Nine times out of ten, the most ruthless will be the ones that survive and thrive, creating a moral vacuum at the top. Warren Buffet is an anomaly, the exception that proves the rule.

        The ‘invisible hand’ is all too invisible.

  5. Jimbob says:

    The reduction in growth of wages should have been offset by the BofE lowering interest rates, which usually puts more money into the pockets of those with mortgages (people and businesses alike), stimulating demand and stimulating labour, until rates are raised again. Since the credit crunch however, the banks have not passed on the benefit of the low interest rates (except to the lucky few on pre-crunch tracker products). Instead, they have increased their margin to shore up their balance sheets. Conventional economic policy has failed because of the continued weakness of the banks.

    1. Anonymous says:

      Hi Jimbob

      We come to the same answer time after time which is that our banks are hindering any real economic recovery. Instead of reform we are dangled a carrot of maybe some cheap shares in Lloyds TSB and RBS. I guess they are playing to greed rather than intelligence.

  6. Ian.Jones says:

    I do believe it is called globalisation. Labour in the West now has to compete with hundreds of millions of additional labour resources in the East. Capital meanwhile can exploit the new opportunities in the East. It is only a matter of time before the Labour in the West comes after the capital holders unless they spread the wealth. I wouldnt hold my breath.

    1. Anonymous says:

      Hi Ian

      Yes plenty of empires have fallen before usually with very unpleasant results.

  7. Paul C says:

    Shaun,

    It is always worth raising the “real income” issue, just so as to make it clear to readers that compound statistics can explain a large portion of pain we suffer everyday but it is a symptom not the cause. To somehow tie together the decision of QE and artificially low central bank rates as part of a coherent remedy for recovery is we all know by now, simply wishful thinking.

    Low interest rates, bank bailouts and Q.E. are desperate measures to keep the UK system from catastrophic failure, they are not a well thought out or long term policy solutions. Each incremental desperate measure takes us even further from a financially sustainable solution (see also Greece bailouts).

    It has been impressive to see how these preventative measures have got us from 2007 to 2013 though, even commendable given the iterative rig-up of each measure. I’ll even remark that pop-corn is the way forward as one of your other commenters often alludes).

    After giving cheap money to first time home buyers we should be in for another impressive measure come 2014. Now let me suggest some ideas….How about we give “free money” to large and trustworthy Corporates to renew our UK infrastructure whilst at the same time promising over the future “tolls” to incentivize them to run them for 50 years:

    Network Rail – Print £35Bn and let them build HS2

    BAA – Print £25Bn and let them build Heathrow2

    MorganSIndall – Print £100Bn and let them resurface the M1 and M6

    Hitachi – Print £150Bn and let them build 1 or 2 Nuclear Power Stations

    Maybe others can add to the list, I may not get all of the plans right first time.

    1. Anonymous says:

      How about we print enough to build 10 British AGRs ? – 1 or 2 reactors aren’t enough to replace the generating capacity.

  8. Anonymous says:

    Shaun – good article and some very interesting comments by folk on discus which is why it is all essential reading! It makes my day that common sense and well argued opinions are ‘out there’ – in contrast to the drivel in most of the media.

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