Fund Managers’ Favourites: Pharmaceutical Focus

Henderson’s John Bennett, who manages €3 billion within his European-focused funds, discusses long-term opportunities in the pharmaceutical sector

Alanna Petroff 10 October, 2012 | 11:29AM
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In the video series, "Fund Managers' Favourites", Morningstar speaks with UK-based fund managers to learn about their top investment picks. In this video, Morningstar journalist Alanna Petroff speaks with John Bennett from Henderson Global Investors about three of his favourite European pharma companies

Securities Mentioned in this Video:

Henderson European Focus Trust (HEFT) (Rating: Bronze)
Henderson European Focus Fund
Henderson European Absolute Return Fund
Henderson European Selected Opportunities (Rating: Bronze)
Henderson Gartmore Continental European Fund (Rating: Bronze)
Novartis (NOVN)
Roche Holding AG (ROG)
Sanofi (SAN)

Video Transcript:

Alanna Petroff: In the Morningstar “Fund Managers’ Favourites” series, we speak with UK based fund managers about their favourite equity picks and investment trends. Joining me today is John Bennett from Henderson Global Investors. He focuses on European equities and is actually the director at Henderson of European equities and he is looking right now at pharma and the long-term opportunities in pharma. So, John, why do you like pharma right now?

John Bennett: Well, I think any investment is comprised of a number of ingredients. In the case of pharma, two of the biggest cases for pharma are the combination of value and change. What you've seen is this industry de-rated enormously over the last 10 to 15 years. Investors were very happy to pay 25 even 30 times for stocks like AstraZeneca, 10 or 15 years ago stocks like Roche for example. That's been crushed way, way down and by the time we got engaged in this sector 18 months ago, you were paying 7 to 9 times earnings, so value was in. The second thing that we needed was change and now we see change.

Petroff: What's the change that you're seeing right now in particular that you think will make this sector and these equities go higher?

Bennett: Well, the catalyst to change was that the old business model was breaking down, the old business model of find blockbuster drugs, get a 15-year patent… That's much more challenged now, much more difficult to find the drugs and get the patents. You saw wholesale management change in this industry--in the European major pharmaceuticals--over the last five to seven years. You've seen huge change at the CEO and CFO level. What they've done is they have gone in and they are not blinded by the sacred-cow nature of the industry. They've gone in and questioned the sacred cows and changed business models.

Petroff: Okay. So you think that the change in the business model will help this industry thrive long-term now?

Bennett: Yeah, because I think what's happened is, I do think investors are guilty of a so-called ‘recency effect.’ They'll look at what happened the last 10 years. Here is an industry that was once a poster-child of growth stock investors and then it became a value sector. What is fantastic about our business is mean reversion, and stocks and industries go through mean reversion, through growth stock favour to value stock disfavour. That change in the industry, not just in valuation, but the people changing the business models, moving in some cases away from pharma to areas like animal health, vaccines, consumer medicines, that change we think is, in a wholesale fashion, under-recognised by the market.

Petroff: Okay, and will be recognised over the next few years over the long-term?

Bennett: Yeah, I think what you're going to – 2012 is, in my view, the trough caused by this headwind known as the patent cliff. This is the trough year in our view for earnings and cash flow growth.

There are many things you can hide in the accounts of companies and EPS and balance sheets, you cannot hide cash flow. This cash flow growth speed in our view is about to pick up. From 31 December 2012, watch the gross speeds pick up from 5s and 6s to high single-digit across this industry.

Petroff: Okay. Now three of your favourite companies right now within the European pharmaceutical sector; well, we have Novartis, Roche Holding and Sanofi. Those are three of your biggest holdings in many of your funds. So let's talk first about Novartis. What's so great about Novartis?

Bennett: I talked about the headwind. It's been fascinating to watch each company adopt a different sort of, in a sense, prescription going forward in terms of how you're going to meet this challenge.

Novartis is very interesting because what I said is, we don't believe in the old model, that old model of a science-based company. Yes, it's still important to us, but actually we're going to spend the cash flow coming from that part of the business on non-pharma businesses. So they went out, they bought Alcon, which is a major player in eye care, contact lenses and other eye care, for example. Away from the threatened sort of prescription-drug model. They've gone into other areas of nutritional foods, et cetera, generics as well.

So they have moved about 45% of their P&L to non-pharma. That will go up to somewhere between 60% and 65% in the coming few years. And the multiple the stock market, in my view, will start to apply to that will be much higher.

Petroff: Okay. Now moving on to Roche, a very different kind of pharma company. Tell me about them.

Bennett: Well, Roche and Sanofi are said to be ‘best of enemies’ because they share the same small town in Switzerland.

Roche has a very different approach. I mean it would possibly even ‘poo-poo’ the Novartis approach. It says, ‘no, we're a clinically-based, science-based company and you know what, we are proven to be excellent in oncology’. And that's right. They will continue to spend above 20% of sales on R&D and that's fine so long as they're successful. It is fine because they are successful. Roche are very, very good and very strong in their oncology franchise. So, oncology plus diagnostics is the way forward for Roche.

Petroff: And Sanofi, why Sanofi?

Bennett: Sanofi, again, a very different approach. In comes a new CEO from Glaxo, in fact, in this country, goes in and he says the first thing we have to do is cut costs. So any bloated R&D or bloated sales forces, he has gone in and he has addressed that. Then we have to turn and face emerging markets. We then have to leverage off the world's biggest selling insulin, Lantus, leverage off the cash flow from that and move it into areas like animal health, vaccines, emerging markets. So, again, a different approach, but a successful approach.

Petroff: What would you say would be potentially the key risks within the pharmaceutical sector as a whole? Maybe one or two key risks.

Bennett: I think the two things I worry about most, and one of them is very much in the headlines, so it's probably not the thing that's going to trip it up… One of them is in the headlines and that's austerity. Whether that's Obama Care, European austerity in the south of Europe could that spread north and therefore huge pressure on drug prices? More pressure on drug prices. If that were to happen, we’d have to readdress the situation.

Second risk I worry about is they’ve all been guilty of big acquisitions in the past. We don't want that. When we meet with the management of those companies, we kinda hammer that home. The feedback we're getting is, yeah, bolt-on acquisitions, but not major acquisitions.

Petroff: Okay. Thank you very much for coming in today.

Bennett: My pleasure.

Petroff: That was John Bennett from Henderson Global Investors. I'm Alanna Petroff. Thanks for watching Morningstar.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Henderson European Focus Trust Ord1,496.28 GBP-2.84Rating
Janus Henderson European Focus A Acc373.73 GBP-0.95Rating
Janus Henderson European Sel Opps A Acc2,216.21 GBP-0.97Rating
Janus Henderson Eurp Abs Ret A Acc192.40 GBP-0.46Rating
Janus HndrsnContinen Eurp X2 EUR13.31 EUR0.24Rating
Novartis AG79.87 CHF0.00Rating
Roche Holding AG360.65 CHF0.00Rating
Sanofi SA90.94 EUR0.00Rating

About Author

Alanna Petroff

Alanna Petroff  is a financial journalist with Morningstar UK.