For many investors, the pharmaceutical industry offers an attractive place to park your money for years or even decades. Drugmakers in the United States are privy to a laundry list of advantages that allow them exceptional pricing power, which, in turn, usually translates into very high margins and sustainable profitability, even in situations where sales volumes are stagnant.
Of course, large pharmaceutical companies, which I would arbitrarily define as having a market valuation of $50 billion or higher, also face the same issues as small- and midsized drug developers: namely the concern of generic competition. Patent protection is finite on all branded therapeutics, meaning large drugmakers tend to turn to mergers and acquisitions (M&A) to fuel the expansion of their pipelines, product portfolios, and bottom-line.
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Two large drugmakers are not like the rest
However, we're at an intriguing crossroads for industries that rely heavily on M&A. The Federal Reserve is tightening monetary policy for essentially the first time in a decade, leading to the expectation that interest rates will continue to head higher in the months and years to come. This would imply that future loans, or any existing loans with variable rates, are going to become pricier.
Now, the good news is that none of the largest drugmakers -- there are 13 in total with a market cap above $50 billion -- are in any way "struggling" given the amount of debt they're carrying around on their balance sheet. But, a vast majority of drugmakers (11 of 13) do have more debt on their balance sheet than cash, meaning their options for future M&A deals could be constrained. The implication would be that the two large drugmakers who have a net cash balance would have the most flexibility when it comes to M&A and pipeline reinvestment moving forward.
Here's a list, in order of market value from largest to smallest, of the 13 largest pharmaceutical companies. Do you think you can spot the two that currently have more cash than debt on their balance sheets?
- Johnson & Johnson
- Roche
- Pfizer
- Novartis
- Merck
- Sanofi
- AbbVie
- GlaxoSmithKline
- Eli Lilly
- Bristol-Myers Squibb
- Novo Nordisk
- AstraZeneca
- Shire
Think you have the right answer? Read on to see if you were right.
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Johnson & Johnson: $13.5 billion in net cash
The largest publicly traded drug company also happens to be the one with the largest net cash position of them all, Johnson & Johnson (JNJ 0.05%). Coincidentally, Johnson & Johnson also happens to be one of just two publicly traded companies (the other being Microsoft) left to bear the "AAA" credit rating from Standard & Poor's, the highest credit rating they can bestow on a publicly traded company.
What makes J&J so unique and profitable is its highly diversified business model and business structure. Johnson & Johnson is comprised of more than 250 subsidiaries, which makes it relatively easy for J&J to add and remove the pieces to its puzzle without disrupting the larger business.
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Though Johnson & Johnson derives nearly half of its business from faster-growing pharmaceuticals, it still generates around 53% of total sales from its medical device and consumer health product segments. Medical devices offer a long-tail growth opportunity as the elderly population in the U.S. ages and succumbs to needing knee and hip replacement surgeries, whereas consumer health products generate consistent cash flow and maintain strong pricing power in pretty much any economic environment.
Interestingly enough, though, J&J may not be net cash positive for much longer. Last month, J&J announced a deal to acquire Swiss-based Actelion's (NASDAQOTH: ALIOF) product portfolio for $30 billion in an all-cash deal. Johnson & Johnson, which is having its top-selling drug Remicade pestered by the launch of a biosimilar drug from Celltrion and Pfizer, is eager to replace potentially lost sales of Remicade with new therapies. It settled on Actelion, which has a number of niche-based pulmonary arterial hypertension drugs. J&J will also get a small stake in Actelion's pipeline, which will be spun off into a separate company before the acquisition is complete. While this Fool isn't personally a fan of the deal, it should help move the needle for J&J.
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Novo Nordisk: $3 billion in net cash
Assuming the dust settles and J&J completes its purchase of Actelion, the only large drugmaker that may be left standing with a net cash position is diabetes powerhouse Novo Nordisk (NVO -0.49%).
Novo Nordisk recently reported its full-year results, noting that its operating profit rose by 6% in 2016. Some of its newer products have taken pharmacy shelves by storm, including weight-management drug Saxenda, which saw sales rise by 245% to about $230 million, and Tresiba, Novo Nordisk's once-daily insulin, which grew by 221%, but still only accounted for around $590 million in sales. Top-selling GLP-1 drug Victoza also rose by 12% in constant currency to nearly $2.9 billion in sales.
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Arguably the biggest concern for Novo Nordisk is that it's still heavily reliant on older insulins (NovoRapid, NovoMix, and Levemir). As my Foolish colleague Brian Orelli recently pointed out, these older insulins are becoming something of a commodity, and drug developers are starting to get bullied on pricing by insurers as next-generation products hit the market. These three medications accounted for 42.5% of Novo Nordisk's sales in 2016. Even with Tresiba, Victoza, and Saxenda sales growing rapidly in local currencies, they're still not making a big enough dent for Novo Nordisk with sales of the aforementioned modern insulin products declining. This dilemma could be the impetus that pushes Novo Nordisk to go shopping.
Looking ahead, Novo Nordisk announced a share repurchasing program of as much as $2.3 billion, but that may not be its only use for its operating cash flow and cash on hand. As my colleague Brian also pointed out, Novo Nordisk has an up-and-coming hemophilia drug segment that's bringing in close to $1.5 billion in sales annually. Hemophilia is a pretty niche space that would likely command strong pricing power. Thus, with next to no debt, Novo Nordisk may be in the best shape of all drugmakers when it comes to future M&A activity and financial flexibility.
