European Pharma Industry Seen ‘Rising From the Ashes’ in Mid-2012

Wall Street Journal | By Sten Stovall

Investment prospects for Europe’s big drug makers look set to improve dramatically from mid-2012, despite the gloomy backdrop facing the sector as the year begins. In 2012, the $50 billion-plus “global wave” of lost revenues from patent expirations on major blockbuster medicines finally hits the entire pharmaceuticals sector. Tightened government health-care budgets and downward pressure on drug prices will also keep hurting.

The sector’s ratings have suffered as a result. Patent losses for the large cap drug makers in Europe will peak this year at an estimated $12 billion, representing around 4% of their overall sales, according to analysts at Credit Suisse. But drug companies haven’t been idle. Their managements have used the run-up to the so-called “patent cliff” to strengthen balance sheets, diversify their businesses and expand into emerging markets. The more fortunate ones have grown pipelines and are launching products, as the WSJ reported last summer.

Many large drug companies have also reconfigured their research and development operations, targeting efficiency savings and productivity improvements and renewing their focus on specialty areas such as oncology and autoimmune diseases. That is finally being noticed by sector experts.
 

Deutsche Bank analysts said in a note to clients last month:
“Despite an inauspicious backdrop in 2012 … we expect investors to gain in confidence in the pharma sector’s ability to return to growth from 2013. The recipe will be a mix of cost savings, growth from non-patent afflicted businesses and new drug sales.”

JPMorgan echoed that sentiment in a note to clients today: “By mid 2012, we expect investors to turn their attention to 2013-2015, when we expect the growth outlook to return to high single digits. 

Hence, once market volatility declines and a focus on fundamentals returns, the relative outperformance of the sector should turn into absolute performance, as the depressed sector multiple of 10x forward P/E, still near historical lows, can expand, on the basis of a much improved mid-term outlook.”

This much brighter outlook for the European pharma sector — which has yet to be reflected in stock valuations — reflects improved late- and early-stage product pipelines within the sector, a more restrained approach to M&A generally, increased cash generation and the spreading policy of returning value to shareholders through dividend payments and share buybacks.
JPMorgan said European drug makers’ pipelines remain an important source of investor demand for the sector. Its analysts said:

“We believe consensus earnings have yet to reflect positive [late stage Phase 3 clinical trial] results targeting peak sales of $20 billion … In the next five years, we expect lower deal activity and hence, we see an opportunity for increased cash returns.”