Tuesday, September 2, 2008

Pharma: Any Upcoming Drugs?

Pharmaceutical companies are trading well below their historical P/E levels. To anyone who follows the industry, this comes as no surprise. After a slew of blockbuster drugs that hit the market several years ago, the R&D departments of the largest companies have been coming up empty as of late. As a result, investors are concerned that revenues currently yielded from drugs that will soon undergo patent expiration are not being replaced.

So why haven't there been any new blockbuster drugs to replace the ones currently in the market? The problem is not a lack of try on the part of the industry. Here's a look at the R&D spend (as a percentage of revenue) for three of the largest US pharmaceuticals over the last couple of decades:With the R&D spend where it is, it's surprising to see the industry can't keep pace with its aging pipeline. So what's going on here? There will always be media airtime for pundits and experts to offer theories as fact to help decipher a phenomenon whose occurrence is difficult to explain. The common arguments are that big pharma is inefficient, has morale problems, and doesn't have the entrepreneurial spirit conducive to innovation.

It's entirely possible that one or more of these arguments is correct. But they rely on anecdotal evidence, and are more likely applicable to a few departments or perhaps one or two entire firms. But it seems far-fetched that these explanations describe an entire industry that spans countless research labs and several companies which have undertaken high-profile upper management changes with the goal of driving innovation.

Its possible that many of the factors resulting in the current weak drug pipelines are out of the realm of human control. The process of discovery relies to a certain extent on luck. Scientists perform experiments with the hope of seeing results, but the slim chances of success for the next big blockbuster drug can result in high volatility in the degree of success: we have good times (like in the 90s when there were blockbusters a-plenty) and bad times.

When we met with Francis Chou last week, famed value investor and founder of billion dollar Chou Associates, he told us that pharmaceutical stocks have been too beaten down by investors. He said with R&D budgets where they are, investors are getting stable cash flows from drugs still on patent, and getting access to drug pipelines that are bound to turn up a share of successes. To spread out risk, Chou recommended buying a basket of these stocks, since it's unclear which of these companies will hit the home runs.


Unknown said...

Pharma has been said to be undervalued for several years now, and yet nothing has materialized. Looking at the value frontier, it seems the generics (specifically India's Ranbaxy and Israel's Teva) are doing better by focusing on high volume, low cost. Nevertheless, with Pfizer and Merck offering div yields at 6.7% and 4.3%, it seems tempting to park some money there and at least wait it out for the next blockbusters.

Anonymous said...

if you wait for that to happen, it will already be priced in...