What Next for Pharmaceuticals?

Pharmaceutical companies have performed well in 2014, helping boost the healthcare index into the top 10. What should investors expect going forward?

Matthew Coffina, CFA 30 December, 2014 | 2:24PM
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Matt Coffina: For Morningstar StockInvestor, I'm Matt Coffina. I'm joined today by Damien Conover, who is the director of our Healthcare team and we are going to talk about pharmaceutical firms pipelines. Damien thanks for joining me.

Damien Conover: Matt thanks for having me.

Coffina: So every year you do this analysis using our proprietary box methodology, we call it, basically to rank the pipelines of big pharma firms. Could you explain a little bit about this methodology, how it works?

Conover: Sure what we are trying to do is really distill the main drivers of large pharmaceutical companies. And so when we are distilling it there are really three key factors, we're looking at. We're looking at pipeline, patent exposure and what we call in line products. Those are products that don't have patent losses over the next five years, but have already been launched. And those are the three factors that really drive our ability to look at the topline performance of these firms where we expect at least over the next five years.

Coffina: So you've been scoring pipelines in this way for a few years now. How has the methodology performed in the past?

Conover: Yeah, we've had a lot of success with the methodology. If we go back to several years ago when we first started this, firms that ranked very well like Abbott (ABT) and Novartis (NOVN) following two years of their high rankings they posted 40% gains. Lot of this had to do with the strengths of their pipeline as well as lacking a lot of patent losses. Really what the methodology is supposed to do.

Coffina: So, which firms scored the best in this year's ranking and why?

Conover: Yeah, this year's ranking the top two firms were Sanofi (SAN) and Merck (MRK), and just taking those one at a time with Merck. Merck's a firm that is really in this transitionary period of reinvigorating its pipeline. What I mean by that? Is when we think about Merck from several years ago, they are really focused on primary care, which worked well, five, 10 years ago. But in today's era of drug development, you really want to be looking at specialty care. And that’s really where Merck is just moving into and really has expanded its pipeline dramatically and should open up great opportunities.

In particular its product for oncology called KEYTRUDA is an immuno-oncology drug that I think will really create a paradigm shift in how we treat very large incident rate cancers like lung cancer.

Sanofi, Sanofi is a firm where the pipeline is not as strong as Merck, but it's a firm that doesn’t have a lot of patent losses. Which in our methodology helps firm just as well, as a firm that has great pipeline. So these two firms we think are very well positioned for topline growth over the next five years.

Coffina: So which firm scored the worst this year?

Conover: Yes, when we look at all the different metrics, Pfizer (PFE) actually comes out pretty poor. And it's a huge firm so you'd anticipate them having a pretty strong pipeline. Unfortunately they really lacked the power of a lot of its peers. And on top of that they still have some major patent losses and when you add that together. The growth rate on the top line looks very, very challenging.

Coffina: And I also want to just talk about GlaxoSmithKline (GSK). So this company I think was our top-ranked firm last year. It's toward the bottom this year, so obviously some things didn't go well in 2014 for Glaxo. What is the big difference between last year and this year?

Conover: Yeah I'd say there are two things that really hit Glaxo hard in 2014. The first is their inline products are facing a lot more competition and a lot more pricing pressure. And the key inline product here is ADVAIR. ADVAIR is a respiratory drug that really had a lot of pricing pressure put on it, by some of the major payers in the US, most notably Express Scripts. Because of that pricing pressure we saw the projected forecast for ADVAIR drop pretty dramatically and really hurt the stock performance.

On top of that there were a lot of, what I would call swing for the fences products in the pipeline, meaning if they had made contact, it could have been home runs, but unfortunately they had two major strikeouts and really hurt their pipeline.

Coffina: Thanks for joining me Damien.

Conover: Yeah, Matt thanks for having me.

Coffina: So in conclusion in this year's big pharma ranking. Merck and Sanofi came out on top. Merck because of its very strong pipeline, Sanofi mostly because of its lack of patent losses over the next five years. On the other end of the spectrum Pfizer and GlaxoSmithKline didn’t score as well in both cases companies are facing patent losses relatively weak inline product sales and not enough in the pipelines to make for that.

For Morningstar StockInvestor I'm Matt Coffina. Thanks for joining us.

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Matthew Coffina, CFA  is a stock analyst at Morningstar.