WCRX Warner Chilcott Plc - Ordinary Shares (MM)

The pharmaceutical industry has been showing signs of recovery from one of the biggest patent cliffs in recent times. Major blockbuster drugs like Merck’s (MRK) Singulair, Pfizer’s (PFE) Lipitor, Forest Laboratories’ (FRX) Lexapro, Sanofi/Bristol-Myers Squibbs’ (SNT/BMY) Plavix and Eli Lilly’s (LLY) Zyprexa lost patent protection in the last few quarters. These products alone represented branded sales worth more than $15 billion.

However, the effect of the genericization of these products was felt mostly in 2012. While the industry won’t be completely free from genericization, the major patent expiries are over and done with. New products should start contributing significantly to results and increased pipeline visibility and appropriate utilization of cash should increase confidence in the sector.

Some products that lost or are slated to lose patent protection in 2013 include:

Source: 10K

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 would recommend investors put their money in 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 oncology, central nervous system disorders, diabetes and immunology/inflammation. The hepatitis C virus (HCV) market is also attracting a lot of attention.

A couple of biotech companies that have been in the news recently due to acquisition rumors/talks are Onyx Pharmaceuticals (ONXX) and Alexion Pharmaceuticals (ALXN). Onyx has placed itself on the market after turning down an offer from biotech major, Amgen (AMGN). Meanwhile, Roche (RHHBY) is rumored to be interested in Alexion.

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

Meanwhile, GlaxoSmithKline (GSK) divested certain non-core brands from its Consumer Healthcare segment. In Aug 2011, AstraZeneca (AZN) sold its Astra Tech business to DENTSPLY (XRAY). 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) also announced its plans to explore strategic alternatives for its ortho-clinical diagnostics business, including a possible divestiture.

Emerging Markets and Biosimilars

Another trend seen in the pharmaceutical sector is a focus on emerging markets. Companies like Mylan (MYL), 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. market -- 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 from genericization.

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), Actavis (ACT) and Teva (TEVA) are all targeting the highly lucrative biosimilars market.

2Q Earnings

So far, 51.1% of the companies falling under the Medical sector have reported second quarter 2013 results. While earnings-beat ratios (percentage of companies coming out with positive surprises) were pretty impressive, revenue-beat ratios and growth ratios were weak.

To date, second quarter 2013 earnings "beat ratio" was 70.8% while the revenue "beat ratio" was 29.2%. Total earnings for this sector were up 1.9%, below the 3.0% growth recorded in the first quarter of 2013. Total revenues moved up 4.1% in the quarter versus 10.7% growth in the first quarter of 2013.

Looking at the consensus earnings expectations for the rest of the year, earnings are expected to decline 3.6% in the third quarter and grow 1.2% in the fourth quarter. Overall, 2013 earnings are expected to decline 0.2%.

This is mainly due to weakness in the pharma industry which accounts for about two-thirds of the sector’s total earnings. Tough comparisons at Pfizer, Merck and others tell the pharmaceutical industry’s earnings growth challenge. Both Pfizer and Merck are facing generic competition for key products.

For a detailed look at the earnings outlook for the Medical and other sectors, please check our weekly Zacks Earnings Trends report.

Focus on New Products

2012 saw the FDA approving 35 novel medicines including the following:  



Source: FDA
Source: FDA

Most of these products should be major contributors to the top-line in 2013. Stivarga, Kalydeco, Xtandi and Kyprolis, especially, represent strong commercial potential.

So far in 2013, quite a few important products have gained approval including Biogen’s oral multiple sclerosis drug Tecfidera, Johnson & Johnson’s type II diabetes drug Invokana, Merck’s Liptruzet (cholesterol) and Forest’s Fetzima (major depressive disorder). Biogen’s Tecfidera is off to a strong start with its launch -- quarter sales are surpassing expectations by a wide margin.

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 #195, med-biomed/gene is #101, med-drugs is #83, while the med-generic drugs is #168. Analyzing the Zacks Industry Rank for different medical segments, it is obvious that while the outlook for large-cap pharma stocks is negative, that for med-drugs is positive. Meanwhile, the outlook for med-biomed/gene and med-generic drugs is neutral.

OPPORTUNITIES

While several companies will continue to face challenges like EU austerity measures and genericization, the pharma industry should be out of the worst of the genericization phase from 2013. Many companies which had faced generic headwinds in the last couple of years should see their results improve from 2013. Cost-cutting, downsizing, streamlining of the pipeline, growth in emerging markets and product approvals should support growth.

Among large-cap pharma stocks, Johnson & Johnson (JNJ) currently holds a Zacks Rank #2 (Buy). The company has performed well in the first half of 2013 and the momentum should continue through the remainder of the year. The company has been trying to offset the declining sales of some of its important products by bringing in new products through in-licensing deals and acquisitions. We believe the diversity and strength of the company’s underlying businesses will continue to provide strong growth in future. The Synthes deal should continue driving results.

Forest Labs (FRX), another Zacks Rank #2 stock, is doing well with first quarter fiscal 2014 results beating expectations. The company has launched several new products over the past few quarters and continues to make impressive progress with its pipeline.

In the biotech space, we are positive on Biogen (BIIB). Tecfidera, the company’s recently launched oral multiple sclerosis drug, is off to a strong start with launch quarter sales coming in at $192 million (including inventory stocking of $82 million). While Tecfidera has the potential to gain the top spot in the oral multiple sclerosis market, Avonex and Tysabri should continue contributing significantly to sales. 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, another Zacks Rank #2 stock, continues to do well in the HIV segment and is also progressing with its HCV pipeline.

Medivation (MDVN), a Zacks Rank #1 (Strong Buy) company, should continue delivering with its prostate cancer therapy, Xtandi, performing well. Based on the data we have seen so far, we believe Xtandi has blockbuster potential. It is currently in several studies including for the pre-chemo setting. Expansion into the pre-chemo setting would be a major positive for Medivation.

Among generic companies, Actavis (ACT) looks well-positioned. We view the acquisition of Actavis Group as a smart strategic move and we believe the company will be able to achieve its guidance easily. We are also positive on the upcoming acquisition of Warner Chilcott (WCRX), which makes strategic and financial sense. 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 #3.

WEAKNESSES

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. The FDA has been exercising more caution in granting approval to new products and several candidates are facing delays in receiving final approval.

Bristol-Myers Squibb (BMY) currently carries a Zacks Rank #5 (Strong Sell). While the company’s second quarter results were in-line with expectations, Bristol-Myers cut its outlook for 2013 reflecting negative currency movement and the recall of Fervex, a local over-the-counter (OTC) product in France and other international markets. Moreover, Eliquis’ performance has been disappointing.

The Medicines Company (MDCO) also carries a Zacks Rank #5. Earnings estimates for this company have been declining with third quarter results expected to remain flat on a sequential basis.

Other companies that currently carry a Zacks Rank #4 (Sell) include Novo Nordisk (NVO), Novartis (NVS), Dendreon Corp. (DNDN) and XOMA Corporation (XOMA), among others.
 
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