Moody's Gets Moody With Drugmakers

European businesses probably wish they could cut back on their imports of bad news from the U.S. this month. Earlier in September, ratings agency Moody's announced a negative outlook for the near-term future of European pharma.

Moody's issues these sectorwide reports to help guide its ratings of a company's and industry's creditworthiness. However, the reports also make interesting reading for anyone seeking a general idea of a particular sector's trends and outlook. In the case of the European large-cap pharmas, Moody's is worried about three negative trends that will hit many such companies in the coming year.

As any Pfizer (NYSE: PFE) or Eli Lilly (NYSE: LLY) investor can tell you, many drugmakers, including large-cap European pharmas, will face patent expirations in the 2010 to 2013 timeframe. GlaxoSmithKline (NYSE: GSK), for instance, stands to lose patent protection on Advair, its asthma treatment, and Avandia, a diabetes drug. As a result, these companies will probably experience huge revenue declines from their top drugs.

These two compounds alone accounted for nearly one-quarter of Glaxo's pharmaceutical sales last year. Many of the other European pharmas, such as AstraZeneca (NYSE: AZN) and Novartis (NYSE: NVS), must also find new ways to fill in sales for blockbuster compounds facing expected generic competition in the 2010-2013 time frame.

If there were a renaissance in drugmakers' pipeline activities, new drugs being developed could easily make up for the lost sales. But as the Moody's report points out, European drugmakers' late-stage pipelines are weaker today than they were even just a couple of years ago.

Combine both of those issues with what appears to be a stricter and more safety-conscious FDA in 2008, and you have a triple whammy of negative variables expected to beat down European drugmakers over the next 12 to 18 months, according to Moody's.

The negative outlook for European pharma means that Moody's will be more likely to downgrade these companies' credit ratings in the future, especially if they continue to leverage their balance sheets. "Large debt-financed acquisitions or share buybacks have somewhat weakened the liquidity profiles of companies involved in these transactions," it writes.

A credit downgrade could mean that European pharmas will pay more interest on any new debt they issue. It might even prevent some of the more conservative-minded drugmakers, or the ones with the shakiest credit ratings, from participating in trends like the recent push to acquire biopharma assets.

All in all, it's a sobering report on the near-term future for European pharma. As we've seen in the financial sector recently, investors should be careful around any company that lets its balance sheet become overleveraged.