Proposed changes to US drug pricing are a threat to the profits made by largest pharmaceutical companies and have put pressure on industry valuations. Government reforms can have an impact on prices and weigh on the strength of moats or competitive advantages – especially regulation from the US government, as the market represents the majority of profits for most of the large drug firms.
With this backdrop of uncertainty, Morningstar equity analysts believe the industry's valuation looks attractive, as new pricing policies are manageable.
Among UK-listed pharmaceutical firms, GlaxoSmithKline (GSK) – which has a wide moat and a four-star rating – faces low exposure to US drug policy changes and represents one of the most undervalued firms in the drug area. Likewise, the majority of AstraZeneca’s (AZN) sales are derived outside the US, so the wide-moat firm faces fewer repercussions from changes to drug pricing there. But Shire (SHP), which could be the subject of a takeover bid from Japan’s Takeda, could see 2019 earnings hit by exposure to the medical benefits coverage market.
International Presence Protects AstraZeneca
We project that AstraZeneca's earnings to face a slightly lower than average impact from policy changes to US drug pricing. With the profit margins much higher in the US, the relatively smaller amount of sales can still mean a higher level of profit exposure.
Overall, AstraZeneca derives the majority of its US sales from the pharmacy benefit channel – ie. where drugs are self-administered by patients. Looking forward, AstraZeneca's outlook is driving toward more exposure to government payment channels, as several of the firm's growth drivers are targeting older patient populations. The likely success of the company's cancer treatment drugs Imfinzi and tremelimumab will increase Astra's sales in the medical benefit channel, where drugs are taken or injected in a hospital or clinic under the supervision of a professional.
With the drugs targeting cancers that tend to occur in older patient populations, Astra's dependence on strong pricing in government channels increases.
Glaxo Backed by Diversified Portfolio
GlaxoSmithKline only has about a third of its revenue derived from US drug sales, which lessens the impact from any pricing policy changes. Further, the company's consumer healthcare division creates additional buffers from any drug pricing changes. Consumer health drugs are generally paid for by the individual rather than through a health policy, and brands play a more important role in differentiating products.
Nevertheless, Glaxo faces some exposure to US drug pricing policy changes as the company lacks many drugs that flow through the medical benefit channel. The company's largest-selling drugs target respiratory disease and HIV. On the respiratory front, we expect sales will fall in the US as generic competition arises for ashthma drug Advair, likely toward the end of 2018.
We believe regulator the FDA wants to focus on lowering drug costs by encouraging more generic drugs. We expect next-generation respiratory drugs and continued growth from HIV drugs to offset the lost Advair sales.
Shire Earnings Exposed
Shire has varying exposure to potential changes to US insurance payments. Shire's US drug sales are relatively normal as a portion of total sales, mostly due to the global nature of sales of its drugs, particularly products like enzyme replacement therapies.
Shire's relatively high exposure to medical benefit coverage leads us to assume a potential 3% earnings hit in 2019 if changes under consideration take effect. Over time, we think Shire's exposure to the US market will remain stable, as it holds global rights for most of its therapies and pipeline. Exposure, excluding the US, could increase as dry-eye treatment Xiidra launches outside the US and as the neuroscience portfolio launches in Japan.
Shire's fastest-growing products such as plasma-derived therapies are medical benefits, and key pipeline drug lanadelumab, for hereditary angioedema or skin swelling, should be a pharmacy benefit but does not cater to an older demographic.
Small Changes Expected
The recent round of policy changes and proposals has weighed on drug company valuations, which are sensitive to the rhetoric coming from Washington policymakers. But given all the value that drugs provide and the relatively low costs of drug spending compared with other parts of the US healthcare system, we don't expect major pricing changes for drugs in the United States.
