In the last two years the pharmaceutical industry has been under the spotlight and registered a generalised financial statements improvement. But will it be long-lasting? Is the pharma sector a safe haven against recession or something more?
Article written by Marco Cazzolli for The Young Economist.
During the past two years, the pharmaceutical industry has been overwhelmed by a previously unknown media notoriety, and there is no doubt that it has proven itself. Probably neither the most optimistic ones were able to predict the development and distribution on a global scale of a vaccine in such a narrow piece of time. This fast response to demand’s needs has reflected on a generalised financial statements improvement of companies operating in this sector.
Let’s try to draw up an overview of the industry, understand which are the main players and eventually get into a financial analysis.
The pharmaceutical industry is made up of companies which manage the research and development, production and consequent commercialisation of drugs intended for both humans and animals.
In the last few years, the sector has been facing a transactional process towards an ever/always greater and more widespread use of biotechnologies applied to the medical field.
Medical biotechnologies permit the development of new analysis methods and disease diagnosis as well as the tuning of active ingredients and production of vaccines. The latter has been essential with the sudden outbreak of a pandemic, and in this context, part of the sector has not disregarded expectations, being able to develop and distribute an anti-Covid vaccine in less than a year. In detail, the partnership between the American Pfizer and the German BioNTech, and then the English-Swedish company AstraZeneca were the first able to place an effective anti-Covid vaccine on the market.
As a whole, the pharmaceutical industry presents a turnover of above a trillion US dollars, in 2021 global revenues touched 1,4 trillion dollars, with a high geographical concentration in North America, where about half the sales come from.
To be precise, in the last decade (2001-2021) the compound annual growth rate was 12,49%, with a great increase in the last biennium primarily benefiting from vaccines commercialisation, but also from the growth in drugs expense pro capita triggered by the pandemic, registering 1,427 trillion dollars in 2021. The pandemic’s reflection on revenues is both direct, through vaccines sales, and indirect, i.e. ancillary related products. Covid-19 has, in fact, changed individual perceptions and habits, making people more careful by utilising personal protective equipment. In addition, governments have imposed the mandatory use of face masks generating a consequent growth in the industry’s income represented by the following graph.
Source: www.statista.com
The industry is characterised by two critical factors: high competition and tight regulation. Regarding regulation, the American government agency FDA (Food and Drug Administration) provides, for a new drug authorisation, a procedure made up of five different phases: discovery/concept; preclinical research; clinical research; FDA review and FDA post-market safety monitoring. On the contrary, the EMA (European Medicines Agency) provides four different procedures, as strict as the American one, to obtain commercialisation authorisation: centralised procedure; decentralised procedure; national procedure and mutual recognition procedure.
Competition, instead, takes different forms, the most typical are: efficacy; safety; ease of use and costs. The competition is further intensified by the crucial role of patents. You witness, indeed, a sort of patent race. This title allows a company, which has created a product and so has got the intellectual property of it, to exploit the invention for a determined period of time preventing competitors from producing it without prior authorisation. The exclusivity period lasts twenty years in both the USA and Europe. Despite the strong competition, we’ve run into few collaborations, an emblematic example is the partnership between the American giant Pfizer and the German BioNTech. The two companies already undertook a research programme aimed at developing anti-influential vaccines in 2018; the partnership has then been strengthened, established, and focused on the production of the first anti-Covid 19 vaccine.
In 2021, it was Pfizer the one to certify itself as market leader with revenues in the pharmaceutical segment of 79,6 billion dollars, followed by AbbVie with 56,1 billion dollars and Johnson&Johnson. J&J registered revenues above 90 billion dollars in 2021 but in different segments: Consumer Health; Medical Device and Pharmaceutical. Precisely, in the latter, the company generated an income of 52,1 billion dollars. The first European company is the German Merck, ranking in seventh place with sales of 42,8 billion dollars.
In the last 5 years, we’ve come across the establishment of the pharmaceutical industry, thanks to diverse M&A operations mainly aimed at increasing innovation. Through M&A, a company incorporates the total assets of the target company including immaterial immobilisations, in particular patents which are fundamental in this sector. The possibility to scale up the business and create economies of purpose is another reason on which acquisitions are based and allow bidder companies to increase turnover, decrease costs and become more competitive in this way.
Eventually, M&A operations can be exploited to redefine products portfolio, through divestments of non-operating assets and the acquisition of innovative start-ups or the ones carrying out complementary or similar activities.
Having defined the general framework of the sector, let’s now delve into the financial analysis aspect, firstly considering macroeconomic factors, in order to then deepen the top three companies of the industry: Pfizer, AbbVie and Johnson&Johnson.
Let’s start with macroeconomic factors. The products offered by the pharmaceutical industry benefit from rigid demand, in fact, in quality of essential goods for their health, people do not desist from buying them but, on the contrary, purchase is often recommended or required by professionals.
On the other hand, pharmaceutical products suffer strong price competition, which you can avoid by filing patents, caused by the presence of many substitute products.
In addition, the pharmaceutical sector can benefit from the predicted growth of global population in the next years. Forecasts state that there will be eleven billion people by 2100. Even more important is the progressive ageing of population, a favourable element for the industry, given the positive correlation between age and health care needs.
From a microeconomic view, analysing the three market leaders, common characteristics arise. All three companies are profitable and present an excellent operating cash-generating capacity: free cash flow to the firm is primarily affected by net income.
In 2021, average ROA (Return on Assets) was 10% (12% Pfizer, 8% AbbVie, 11% Johnson&Johnson), while average EBITDA margin was 30% (29% Pfizer, 34% AbbVie, 26% Johnson&Johnson). The importance innovation brings with itself is certified by average R&D/Revenues which was 15% (17% Pfizer, 13% AbbVie, 15% Johnson&Johnson).
The average ROE was 44% but with a high volatility: both Pfizer and J&J registered a return on equity of 28%, while AbbVie’s ROE was 75%. The latter, on the economic side, benefited from a sales’ sharp increase which resulted in a higher net profit, but on the asset side has been having an equity deficit, characterised by high financial leverage: as a matter of fact, if Pfizer and J&J present a current D/E in the range of 0,4-0,5; AbbVie present a value of 4,9 mainly resulting from the recent buy-out of Allergan.
The following chart shows the main KPI and their evolution from 2018 to 2021.
Source: Elaboration from companies financial statements.
Eventually, it is interesting how the first ten industry’s companies overperformed the market in the past six months, highlighting an excellent sector’s financial health status. As explained by Antonio (Tony) Despirito, CIO of U.S. fundamental Active Equity and lead portfolio manager of BlackRock, during his last Bloomberg’s interview, where he stated that the pharmaceutical industry represents an outstanding investment opportunity to protect capital and get a profit in recessive periods like the current one, because it is rich of so-called “stable compounders”, i.e. high quality companies which can generate return on an ongoing basis.
Source: www.yahoofinance.com
Extending the time frame to five years, only AstraZeneca, AbbVie, Pfizer, and Merck have actually been able to beat the market. The underlying graph rescales the latest industry performance, in spite of that, results are positive, suffice it to say that the lowest return is of gsk (GlaxoSmithKline) +13,95%, establishing the role of “stable compounders” described by Despirito.
Source: www.yahoofinance.com
In the last two years pharmaceutical industry has been under the spotlight, an apparently unappealing and static sector but which has proven itself able to guide innovation. The recent stock growth has partially been result of macroeconomic contingences such as the pandemic and the ghost of recession which has brought to a more warily portfolio repositioning.
As analysed, the main players of the sector benefit from excellent fundamentals which, if consistent with investor’s strategies, can lead to the creation of a “diversified stable compounder portfolio” where the role of pharmaceutical companies is not restricted to that of a safe haven.