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Worrying about Pharma

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By WCMinor
November 4, 2002

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Pharma Fools,

I work for a pharmaceutical company and think it is a great industry because we get to help people, advance science and make good money all at the same time. As an investor I have about a sixth of my savings invested in pharma stocks but I am concerned about the following trends and wanted to post them for discussion:

1. Productivity has been declining for years and is set to continue to decline. By productivity I mean the amount of money it takes to bring a new drug to market (i.e. greater cost = lower productivity). New advances (genomics, proteomics, gene-based drug discovery, etc.) are most likely to increase the expenses of drug development as that is the trend of the past several decades of scientific advancement. The amount of time it takes to bring a new drug to market from its first discovery is relatively unchanged despite some very significant technical advances in drug discovery and screening.

2. CEO's are overestimating how many new drug applications will be successful each year. The overestimation is at its worst for NDA's of new chemical entities, the genuinely new products which are must important to medicine and, ultimately to pharmaceutical profits. Many are projecting rates of 2-3 NDA filings a year for the next several years; I would expect them to actually achieve something on the order of 0.5-1.0 NDA approvals a year if they match their historical rates and less if they don't.

3. Sales growth is being generated by shifting patients to more expensive drugs. Most companies will give some estimate of the amount of top-line revenue growth, which is due to price increases, and the amount that is due to volume growth. These figures almost always show that price increases are responsible for little or no growth; that is, that growth is due to volume increases. However, the figures are misleading because they do not account for the difference in revenues being generated by shifting demand from older, cheaper products to newer more expensive products. That shift is becoming more important than actual growth in demand for drugs as measured by growth in numbers of prescriptions. Some of these more expensive drugs are better (safer or more effective) than the drugs they replace but many are not and the more expensive drugs become the more vulnerable they are to arbitrary price cuts.

4. At the currently successful pharmaceutical firms, profit growth is greater than top-line growth and has been for some years. What this means is that margins are being expanded through cost cutting and shifts in product mix to higher-margin products. Neither of those trends can go on forever. I believe this need to continue to show bottom-line profit growth is one of the drivers for mega-mergers by companies like Pfizer and Glaxo-Smithkline because a merger creates opportunities for cost consolidation, but that this cost-consolidation is not the same thing as a real increase in productivity, i.e. bringing new products to market faster or more cheaply.

5. Profits are increasingly dependent on sales from one country, the U.S., where political pressures could result in across-the-board, sudden decreases in drug prices.

WCMinor


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