The life of a buy-and-hold pharmaceuticals investor used to be fairly simple in the 1990s and 2000s. They would sit back, relax, and enjoy their 80%-plus gross margin and premium dividend yield without a care in the world.
But times have changed.
Now, you can scare the daylights out of that same long-term investor by repeating two simple words: patent cliff. Because branded pharmaceuticals have a finite period of patent protection, a number of the world's largest pharmaceutical providers are struggling to find new sources of growth with some of their key drugs giving way to generic competition.
Perhaps the poster child has been Eli Lilly (NYSE:LLY) which could see up to three-quarters of its product portfolio come under generic pressure between 2010 and 2017. Making matters worse, Eli Lilly has had a number of critical late-stage trial failures in recent years, including solanezumab, which failed to meet its primary endpoint in Alzheimer's disease, and edivoxetine for depression and ramucirumab for breast cancer. This is one reason I often refer to Eli Lilly as Big Pharma's most perilous pipeline.
Three ways to beat the patent cliff
There really are three primary solutions to getting over the patent cliff hump for Big Pharma.
No. 1 is to innovate, which is our "duh!" moment for this article. Not only do these big pharmas need to innovate, but they also need to see late-stage success and approval for their product.
Secondly, they can buy growth, just as Amgen did by purchasing Onyx Pharmaceuticals last year to get a hold of its growing line of cancer therapeutics.
Finally, Big Pharma can look across the pond for growth. The U.S. might represent the mecca of pharmacologic opportunity, but sales potential in rapidly growing emerging markets offers a much greater opportunity for expansion.
Today we're going to focus on that emerging market sales potential and, thanks to the hard work of FierceBiotech, which scoured annual reports and earnings calls last year, note which five big pharmas have the strongest ties to emerging markets. Once we understand which companies have pushed into these rapidly growing countries, we might have a better idea which larger pharmaceutical companies have the best long-term growth rate potential.
First, though, before we dive into the top five, let's look at the main advantages and disadvantages of emerging market opportunities.
Emerging markets: the good and the bad
The obvious benefit of emerging markets, as I touched on already, is their high growth rate. Emerging-market countries achieve this growth rate because their own need for infrastructure, or their reliance on domestic commodities, drives growth independently without the need for a lot of outside help. The translation is that weakness in the world's most industrialized nations won't necessarily hurt an emerging-market country.
Emerging markets are also largely underrepresented regions for most medicines, ranging from sophisticated cancer medications all the way down to vaccines that we would consider basic in the United States. This means that while Big Pharma needs to remain vigilant with its innovative capacity, it can possibly translate even its most basic medicines and vaccines to big gains in many emerging markets.
On the flipside, the differing political landscape of foreign markets have made this transition difficult at times. Big pharmas that are operating in emerging markets have encountered geopolitical issues, infrastructure problems (literally, an inability to access or service select regions of a country because of lack of proper infrastructure), patent questions, and funding/reimbursement issues with their therapies, just to name a few problems.
Five countries with the strongest ties to emerging markets
Still, even with these concerns, the allure of emerging markets is simply too great for many big pharmas to ignore. Let's now look at the five which have the strongest ties to emerging-market countries (emerging-market sales data from FierceBiotech).
No. 5: Novartis (NYSE:NVS), percentage of sales in emerging markets: 24%
In fiscal 2013, Novartis had little trouble finding its groove in emerging markets, which is anyplace outside the U.S., Canada, Western Europe, Japan, Australia, and New Zealand. Revenue grew 10% for the year, with its biggest gains seen in China and Russia. Specifically, it was helped by strong sales from its Sandoz generic-drug division and partially offset by unfavorable foreign currency translation. Considering that emerging markets can often have citizens who are strapped for cash, focusing its therapies on available generic drugs could be an incredibly smart move for Novartis. Although it could mean lower margins in the interim, it will likely result in impressive volume.
No. 4: GlaxoSmithKline (NYSE:GSK), percentage of sales in emerging markets: 26%
Things have been a bit more dicey for GlaxoSmithKline, which has found itself mired in a bribery scandal in China, where sales had previously been soaring. Excluding the negative effect within China, GlaxoSmithKline still delivered 5% growth in emerging markets for the year and 11% year over year in the fourth quarter. Similar to Novarits, GlaxoSmithKline has relied on discounting existing medicines and focusing on generics to drive profits. Generic margins are considerably lower than branded pharmaceuticals, but if Glaxo can sell enough quantity, then it gets the same results. GlaxoSmithKline also announced plans in fiscal 2013 to build a manufacturing plant in India, another burgeoning market for pharmacologic products.
No. 3: Merck KGaA, percentage of sales in emerging markets: 29%
Merck KGaA might be the smallest on this list in terms of sales, but it remains clearly focus on ensuring that emerging market growth remains in the forefront of its five-year growth plans. In its 2013 annual report, Merck KGaA reported 9.3% organic growth in its emerging-market regions, with its top performance noted in Asia and Latin America. The annual report (page 33 for those interested; link opens a PDF) notes that Glucophage, a first-line type 2 diabetes treatment that long since saw its patents expire in the U.S., and Concor, a chronic cardiovascular disease drug, helped drive its emerging-market sales the most thanks to improved life expectancies, growing wealth, and improved lifestyle habits in both Asia and Latin America.
No. 2: Sanofi (NYSE:SNY), percentage of sales in emerging markets: 31.9%
Like many of the big pharmas we've described so far, Sanofi's emerging-market success is a direct relation to its focus on generic and lower-cost products where possible. As Sanofi noted in its latest annual report, AllSTAR, a reusable insulin pen for administering Lantus, the world's No. 1-selling insulin brand, to people with diabetes, is a primary growth driver in emerging markets. Sanofi also delivered impressive growth in its consumer health-care division from emerging markets. This segment covers medicines focused on cough and cold remedies, vitamins, minerals and supplements, and anti-allergics, to name a few items. Don't forget that Sanofi also owns the lion's share of the flu vaccine market in the U.S., so look for that to potentially translate into a new source of emerging market success in the coming years.
No. 1: Bayer (NASDAQOTH:BAYRY), percentage of sales in emerging markets: 33.2%
However, leading all big pharmas in emerging-market sales exposure relative to total revenue is Bayer Healthcare. In fiscal 2013, Bayer reported a modest 2.5% increase in total revenue but noted that emerging markets like Asia and Latin America led the way again with 4.7% full-year growth. Bayer has made no secret that it's focusing its efforts on China, Russia, and Brazil to grow its business as it delivered particularly stronger consumer health segment growth from these regions. In Russia, for example, the government has instituted a "Pharma 2020" program designed to improve life expectancy by 10 years by 2020. Bayer is anticipating playing a big role in that government movement.
What we've seen here from these five Big Pharma stocks is that emerging markets offer a nice balance from the stodgy and more mature growth of developed countries. Of course, investors will want to consider other risks such as infrastructure issues as well as patent claims in these regions, but the overall risk versus reward appears favorable for these companies. I would certainly suggest that these five companies have the opportunity to handily outperform their peers, which have chosen to focus primarily on developed countries.
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Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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