Are Drug Companies Being Shortsighted With R&D?

There's no easy way to sugarcoat this: Many pharmaceutical companies are in for a world of hurt. It'll be really hard for these companies to increase profits when top-selling drugs suddenly face generic competition, sending their revenue hurtling toward zero.

Sure, companies can cut back on staff and announce major restructuring plans. But they shouldn't reduce research and development spending; it's the life blood of drug developers, and a major determinant of a company's future growth prospects.

Yet R&D must look tantalizing for companies eyeing cutbacks. Given the years-long development cycle for drugs, any return on investment might not be seen for a long time. In the shortsighted world of Wall Street, where the latest quarter matters more than the years down the road, CEOs might be tempted to trim a little just to boost the current bottom line.

Let's take a look
It turns out that companies in the pharmaceutical industry span a whole range of shortsightedness:

Company

Change in revenue (YOY) (TTM)

Change in R&D spending (YOY) (TTM)

Pfizer (NYSE: PFE  )

0.8%

(5.7)%

GlaxoSmithKline (NYSE: GSK  )

0.6%*

(3.4)%

Bristol-Myers Squibb (NYSE: BMY  )

28.7%

5.6%

Eli Lilly (NYSE: LLY  )

16.3%

9.8%

Merck (NYSE: MRK  )

3.7%

11.3%

AstraZeneca (NYSE: AZN  )

10.9%

13.9%

Schering-Plough (NYSE: SGP  )

41.6%

28.7%

Source: Capital IQ. TTM is trailing 12 months.*In British pounds.

Interestingly, Pfizer and Glaxo, which have both seen their revenue growth tread water, have also cut their R&D spending. Coincidence? Maybe, but the cuts suggest efforts to prop up earnings in a tough environment.

AstraZeneca and Schering's increased spending certainly looks impressive, but both companies picked up a lot of drug candidates with their acquisitions of MedImmune and Organon BioSciences, respectively. Still, the companies seem to be capably supporting their newly stocked pipelines.

Bristol-Myers and Lilly's stellar revenue growth hasn't translated into an equal increase in R&D spending. Unless the companies have suddenly found the secret to researching more effectively with less money, it's unlikely that either will continue to see growth in revenue or earnings down the road without stepping on the R&D spending pedal.

Perhaps most impressive is Merck, which has increased its research and development spending even amid less than impressive revenue and earnings growth. The company came back from the loss of Vioxx, and it seems to be planning for another comeback after the loss of osteoporosis drug Fosamax and slowing sales of Vytorin and Zetia. Don't look for an overnight success story, but the increased spending bodes well for Merck's prospects.

More to the numbers
Of course, companies spend more money than shows up in their R&D numbers to expand their pipelines.

For instance, Pfizer acquired both Encysive Pharmaceuticals and Sernex in the second quarter of this year. It recorded $156 million in R&D expenses for the in-process research and development from these two companies, and $450 million in intangible assets related to the intellectual property of their product pipelines and goodwill. So not all of what is spent to expand a pipeline shows up in the table above, even though the acquired pipeline candidates should have an effect on revenue down the road.

Also, long-term investors realize that one year does not make a trend. A lot of issues can affect R&D spending in the short term. For instance, wrapping up large clinical trials, successful or not, will cause research and development spending to slip before the next compound moves in to replace it.

What counts
The important thing for investors to look for is that companies are restocking their pipelines and moving the compounds through the clinic, so that the Food and Drug Administration can make a ruling on them. Successfully doing so is the only way companies will have enough cash to grow and continue paying out their dividends.

Pfizer, Eli Lilly, and Glaxo are all Motley Fool Income Investor picks. To see how dividend-paying stocks can offer both secure income and the opportunity for growth, take a free look at this newsletter with a 30-day trial subscription.

Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. Pfizer is also a recommendation of the Inside Value newsletter. The Fool has invested a lot in the development of its disclosure policy.


Read/Post Comments (0) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

DocumentId: 724422, ~/Articles/ArticleHandler.aspx, 4/17/2014 2:54:46 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

TREND TRACKER: Get Rich When the Web Goes Dark

It's time to say "goodbye" to your Internet! One bleeding-edge technology is about to put the World Wide Web to bed. And if you act right away, it could make you wildly rich. Experts are calling it the single largest business opportunity in the history of capitalism… The Economist is calling it "transformative"... but you'll probably just call it "how I made my millions." Big money is already on the move. Don't be too late to the party – find out the 1 stock to own when the Web goes dark.


Advertisement