Drugmakers' Research Habit

10/22/2012


The success of the pharmaceutical industry revolves around research.

While drugmakers have grown R&D spending over time, it tends to remain fairly steady as a percentage of revenue. Members of the Pharmaceutical Research and Manufacturers of America (PhRMA) — which combine to account for roughly two-thirds of global R&D spending — have committed between 15.5% and 17.5% of sales to R&D in each of the last 20 years. In contrast, industrial stocks allocated just 2% of revenue to R&D last year.

Drugmakers must keep up that spending because without a stream of new products, revenue will eventually evaporate. Once a drug's patent expires, cheaper generics can flood the market and undercut the original brand, siphoning off up to 80% of the innovator's revenue. This erosion has worsened over time, with generics accounting for 80% of prescriptions last year, up from just 49% in 2000.

Compounding the problem is a decline in the yield on drugmakers' research spending. A KMPG report estimates that drugmakers' return on research investments dipped to 10% in 2010 from 17% in 1990.

Patent expirations and declining research productivity have weighed on drug stocks. Over the last decade, the S&P 1500 Pharmaceutical Industry Index rose just 24%, versus 63% for the broader health-care sector index. But over the last 12 months, the drug index gained 27%, outperforming the S&P 1500 Index and only slightly lagging the sector index.

KEY PATENT EXPIRATIONS
We exclude drugs that account for less than 4% of company sales.
Company (Price; Ticker)
Drug
Patent
Expiration
 
Annual Sales In Billions
(% Of Total)
AstraZeneca ($47; AZN)
Seroquel IR
2012
 
4.34
(13)
Nexium
2014
 
4.43
(13)
Symbicort
2015
 
3.15
(9)
Crestor
2016
 
6.62
(19)
           
Pfizer ($26; PFE)
Celebrex
2014
 
2.52
(4)
           
Merck ($47; MRK)
Singulair
2012
 
5.48
(11)
           
Eli Lilly ($54; LLY)
Humalog
2013
 
2.37
(10)
Cymbalta
2013
 
4.16
(17)
Evista
2014
 
1.07
(4)
           
Amgen ($88; AMGN)
Neupogen
2013
 
1.26
(8)
Neulasta
2015
 
3.95
(25)
Epogen
2015
 
2.04
(13)
Sensipar
2015
 
0.81
(5)
           
Johnson & John. ($70; JNJ)
Remicade
2014
 
5.49
(8)
           
Abbott Labs ($72; ABT)
Trlipix/Tricor
2013
 
1.69
(4)
Humira
2016
 
7.93
(20)
           
Bristol-Myers ($34; BMY)
Plavix
2012
 
7.09
(33)
Avapro
2012
 
0.95
(4)
Abilify
2015
 
2.76
(13)
Sources: Medical Marketing & Media, company reports.

In 2011, the number of failed clinical trials declined, while the FDA approved 129 drugs, the most since 2004. And researcher IMS says patent expirations should peak this year. Several large drugmakers — including Amgen ($88; AMGN), AstraZeneca ($47; AZN), Eli Lilly ($54; LLY) and Bristol-Myers Squibb ($34; BMY) — could see drugs generating more than 30% of their revenue come off patent from 2012 through 2016. But for the industry as a whole, the worst of the patent expirations appears to be over.

However, while the drug industry's arrow seems to point up, we're not yet ready to jump in. The median drugmaker in the S&P 1500 delivered 6% profit growth over the past year and is expected to grow profits just 2% in the current year. In addition, the stocks aren't cheap, averaging P/E ratios of 16 and Quadrix® Value scores of 47. At the moment, we recommend only one drug company — Abbott Laboratories ($72; ABT), a Long-Term Buy.


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