The Valuentum analyst team digs deep into recent trends in big pharma and biotech from the lofty pricing of drugs to political and competitive pressures to ETF considerations and beyond. ~10 mins.
If you cannot view the podcast below, please view the transcript below or select the link here.
Tickerized for holdings in the XLV and IBB.
Brian Nelson, CFA
Gilead’s (GILD) hepatitis C regimen, almost a hundred thousand dollars. Vertex’s (VRTX) cystic fibrosis drug — hundreds of thousands of dollars per year. Have the drug companies lost their mind?
This is Brian Nelson from Valuentum Securities, and today joining me is Mr. Kris Rosemann and Mr. Chris Araos — and we are going to talk everything healthcare, biotech… Mr. Araos, I will start with you, maybe set the tone about what we’re seeing in today’s environment?
Christopher Araos:
Drug pricing has come under intense scrutiny in the past two years, especially if you look up Hillary Clinton or Bernie Sanders. It is worth noting that on an annual rate a 1-10% increase in price of a drug does not draw much scrutiny. Most people would just bat an eye at that. However, if it (the drug price) more than doubles or even exceeds that, it would draw much media pressure and scrutiny.
A current example of that would be the leukemia drug produced by Ariad Pharma (ARIA). Since 2012, it has raised the price four times, and it is currently standing at $199,000 a year. However, it is noted that limited patients can use the drug because it is targeting a specific kind of leukemia.
Brian:
Interesting, so another example where the drug price is the cost of a house in a nice neighborhood — for one year of its use. The drug companies would say that they’re investing all of this money with no guarantee of success, and this is the way they recoup their costs. Mr. Kris Rosemann, what are some of your thoughts on this topic?
Kris Rosemann:
Yes, so we have been witnessing a lot of political pressure as Mr. Araos mentioned around the drug pricing market. Some of the pushback has been coming from the pharma lobbyists — they need to do a better job of educating the general public as well as politicians about what you mention — the process that goes into creating one of those drugs.
A recent example of the difficulty, or the low probability of even some of these late-stage drugs — these drugs that are in the late stages of development — is Opdivo, a Bristol Myers (BMY) lung cancer drug. The story speaks to the different applications available in the pharmaceutical market, but also speaks to the difficulties that companies can find and identifying which areas they should be targeting. This drug has already been successful in a number of applications but very recently it failed to beat chemotherapy as a first line of treatment in certain forms of lung cancer.
That was a huge blow of negative news to Bristol Meyers [see video] as one of their late-stage drugs that they were counting on to be an additional driver of growth for them backfired. That is an example of what can happen to a drug company that might put all of its eggs into one of these baskets.
Brian:
So not only are there biotechs that can’t get a drug to market, but even for certain drugs that have high expectations, as in this case, seeing disappointment for other areas of application could be a pretty shocking development for their stock prices. This is why this industry tends to be extremely volatile.
When you look at our run-in on with Gilead, the branded dynamics of developing a cure for hepatitis C seemed like a slam dunk — and it has been a boon for Gilead’s business. But what we have seen now is that companies like Merck (MRK) and others that are developing, in some cases cures for hep-C, are truncating the opportunity, pricing their drugs more aggressively.
Even the “moaty” aspects of having a branded drug in a dominant area don’t stack up sometimes to what one might expect. There are a lot of challenges that these drug companies face, and it doesn’t seem as if it is always a cut-and-dry scenario.
Kris:
There are a few other dynamics — you pointed to the political and the increasing competition as we continue to move forward in the generic market. There are a lot of biosimilars entering the market and really competing with those branded drugs that you alluded to.
There’s also been an increase in the number of drugs approved as of late. In 2015, for example, the FDA approved the second-most number of drugs in its history, the most coming in 1996 — it is really coming from oncology. We continue to see lots of growth in oncology.
Brian:
That’s an interesting development because…
Rewinding back four to five years, I think most of the market had been concerned about this patent cliff — all these drugs that were going to come off a patent. We saw that in big pharma, where a lot of their revenue performance came under pressure.
Now, we are hearing about a resurgence of new drugs coming to market, and the pipelines of big pharma and biotech have been flush. One of our favorite companies to “play” this area is Johnson & Johnson (JNJ), which has had tremendous growth in its pharmaceutical business, and its pipeline is one of the best pipelines out there.
Kris:
Yes, I think they (J&J) have ten products that they plan to launch between now and 2019 that have a billion dollars in annual sales potential (individually).
Brian:
Yes and the beautiful thing about Johnson & Johnson is that not only do you get that, but you get their consumer business as well — and also a pretty strong medical device segment. J&J is a holding in both of our newsletter portfolios, both the Best Ideas Newsletter portfolio and Dividend Growth Newsletter portfolio. We think its dividend is about as strong as it gets for a company of its size and strength.
Kris:
I think it is important we point to Johnson & Johnson’s pipeline as a key reason we continue to hold it (in the newsletter portfolios) as pricing pressures continue to proliferate throughout the pharma industry. Something else we are beginning to see more and more of is consolidation among health insurers and healthcare payers. There is just tons of consolidation in recent years in the hundreds of billions of dollars in 2015 alone.
Brian:
Everybody is jockeying for position to have power at the negotiations table.
Kris:
Right, as doctors and healthcare payers continue to attempt to reign in the healthcare spending in the United States, which…accounts for almost 18% of total GDP in the country.
Brian:
That’s very interesting. The pharmacy benefit managers (PBMs), what we have seen, they have actually been pursuing exclusive arrangements with certain drug makers to levy their bargaining power and their positions to drive prices lower and to increase competition.
Kris:
Yes, as you mention, the competing parts of the health care sector who are jockeying for pricing power, how might we best be able to get exposure to the entire pie (potential industry earnings), instead of a segmented individual equity?
Brian:
That’s a great question because I think the conversation shouldn’t be necessarily about who will be the winner in certain applications within the pharmaceutical and biotechnology sectors, but how to play this growing pie as demographics continue to be in favor, as this particular sector continues to drive research and development further with new drugs being developed all the time.
We think one of the risk-adjusted ways to “play” this theme is through the Health Care Select Sector SPDR (XLV), where a holder of this ETF has exposure to a large number of different companies across the healthcare spectrum to capitalize on increased spending. So you don’t have the instances where there may be a shock of a disappointment within a company’s pipeline or a failure of achieving a new application for the drug — where a holder of this ETF captures the entire pie of the healthcare value chain.
Kris:
You mention Johnson & Johnson — that is a top holding of XLV at almost 12% (at the time of this podcast). Its top ten holdings are just full of big pharma companies like Pfizer (PFE), Merck, and Medtronic (MDT), which we are also very fond of. It also has major healthcare plan companies — such as United Health Group — which as you mentioned before helps to capture that entire pie of the pharma and healthcare spending industry.
Brian:
This is Brian Nelson for Valuentum Securities. Thank you for joining us.