Don’t Ignore European Healthcare Stocks

A population of 741 million people makes Europe a huge market for drugmakers, yet most investors avoid European healthcare stocks in their portfolios. Is that a mistake? It could be, especially when it comes to Sanofi SA (SNY -2.27%), a French biopharma giant that's trading at a reasonable valuation and offers a market-trouncing dividend yield.

In this episode of The Motley Fool's Industry Focus: Healthcare, analyst Kristine Harjes and Motley Fool contributor Todd Campbell explain how drug approvals work in Europe and why Sanofi ought to be a stock that's on your radar.

A full transcript follows the video.

This video was recorded on May 16, 2018.

Kristine Harjes: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. I'm your Healthcare host, Kristine Harjes, and I have my usual sidekick, Todd Campbell, calling in. It's May 16th, and we're smack in the middle of an International Theme Week here on Industry Focus. Because we're a U.S.-based podcast talking about the U.S. stock market, we spend most of our time talking about domestic companies. But there's a whole world of stocks out there, and no portfolio is truly diversified without international exposure. So, this week, we decided to change things up by focusing on international stories.

We'll start our show today with a high-level overview of how the drug approval process works in Europe, noting the key ways in which it's different from the U.S. system and why it matters to your portfolio. Then we'll turn to Sanofi, France's largest drug maker.

But, first things first, what do our listeners need to know about drug approval in Europe?

Todd Campbell: Well, it's a little bit different than it is in the U.S. There's some nuances that people ought to be aware of. I think, Kristine, one of the things that might be helpful to listeners, just to put things into context and to add on to what you've already said, is just how big the market is for medicine in Europe. I think, in the U.S., as U.S. investors, we tend to look at the U.S. market and recognize that, yeah, the U.S. market in dollar terms is the biggest market on the planet. But the European market is still incredibly significant. There are 741 million people who live in Europe, Kristine.

Harjes: Yeah, it's not insignificant. It's something that, even if you are looking at domestic companies, U.S.-based companies, they're still probably going to have some European exposure. If you can get a drug approved in the United States, a lot of people consider our standards the strictest, then you might as well go ahead and look to get it approved internationally, as well.

Campbell: Right. In the olden times, European approval was done on a decentralized basis -- so, you had to go to each individual country. You can imagine what a pain in the butt that would be. I have to get approved in Switzerland, I have to get approved in the U.K., I have to get approved in Germany, I have to get approved in Sweden, Finland, etc. Obviously, that wasn't the most efficient system. However, since the European Union was formed, they've set up a regulatory process over in the E.U. in the 90s that's a little bit similar to the Food and Drug Administration here in the United States in that it provides a centralized review process. 

Again, we talked about the nuances that people have to be aware of between the two approaches to approval. But, I think what's helpful, maybe, is to know that on in clinical trial basis, in the U.S., you have to get approval to begin clinical trials with the FDA. In Europe, it's still done on a decentralized country-by-country basis. Once those trials are complete, however, the new drug application would get submitted to the EMA, which is the centralized body that will consider the approval of any drugs for member countries in Europe. Similarly, in the U.S., you would submit it to the FDA for approval.

Once it's submitted, both agencies have their own independent review mechanisms. In the U.S., maybe they convene a group of experts and have an advisory committee meeting. Similarly, in the E.U., they would convene a group of experts there to offer up an opinion. Then, again, in both of those systems, the regulatory body doesn't have to listen to the advisors, but usually they do.

Harjes: Exactly. In many ways, there are parallels between the FDA and the EMA, the European Medicines Agency. But where the system really starts to differentiate itself is what happens after that central agency says, "Yes, this drug can be approved." In the United States, after that, you're pretty much good to go. You can get on the market and start selling it. 

But in Europe, the key difference to note is that the drug makers must then go nation by nation to get reimbursement approval. And that's because, in these countries, since there is a centralized universal health insurance program, it's the government itself that's going to wind up paying for these drugs, so they want to be able to negotiate a price. And if the price isn't deemed worth it, or if, for whatever reason, they don't want to cover this drug, they don't have to. And that's a conversation that the drug maker must have country by country.

Campbell: Right. If you look at the studies of the review times that it takes for drugs that are filed for approval in the U.S. to win an OK versus in Europe to win an OK, the U.S. typically comes in a little bit faster. But, they're not too much different, as far as how long it takes to get a drug approval. But, I think what you're talking about with the individual obtaining reimbursement, that's maybe what shifts more companies to say, "I'm going to focus on the U.S. first." Because you're right, winning approval for reimbursement in each one of these member states can be a time-consuming and arduous process. Probably the best example of that, Kristine, is what happens in the United Kingdom, right?

Harjes: Yep!

Campbell: The United Kingdom has NICE, which is a regulatory body whose sole function is to look at the value that's created by drugs that have been approved for use in the European Union. Then, based upon determining value, and they use statistical formulas to determine that, they'll decide whether or not they agree to reimburse for it. Oftentimes, you end up with situations where, yeah, we've crossed all our T's and dotted all our I's, jumped over all of our hurdles, overcome all our obstacles and won approval in Europe, but NICE says, "Nope, your drug is priced too high for the value that we believe it adds to our population."

Harjes: There's an interesting philosophical rabbit hole you can go down here regarding how exactly you do come up with that calculation. Like you said, Todd, it's completely statistical. It's based on the quality-adjusted life year metric, or the QALY. It then affixes a price to that to say how much a life year is worth; how much, as a government, do we want to pay for a drug that gives somebody one more year. Or, the quality-adjusted is, maybe it's multiple years, but they're not quite at full health, so then you adjust for that. 

I don't know, there's a lot to think about there. I don't want to unpack that too much, because I think we could probably do an entire episode on that. But, it's an interesting differentiation between how things work in the United States, where you do sometimes see private payer pushback on prices, but it's completely different than seeing it in a centralized location.

Campbell: Yeah. I think that's kind of the hiccup. If you're looking at it and saying, what's the biggest difference between these two marketplaces, that would be it, is the fact that in the U.S., it's fully centralized. And then, of course, it goes to the private payers or Medicare or whatever to negotiate pricing. But, the drugs are typically available, and those conversations usually happen relatively quickly. But, in Europe, because you have all of these different cooks in the kitchen, it becomes a much longer process and sometimes a little bit more difficult process. So, I think that, from an investing standpoint, what investors want to know is, if I hear that a drug has been approved in the European Union by the EMA, I guess I probably shouldn't jump to think that we're going to start seeing meaningful revenue in Europe right away. It'll probably be best to model a benefit from European sales as occurring over a course of maybe one to three years.

Harjes: Yeah, absolutely. But, it can still be interesting for some of the drugs that are approved first in the E.U., which is not as common, but it can sometimes be an indicator of how a drug might fare over in the U.S. 

One place in particular where we get that sort of perspective is with biosimilars. Listeners who are familiar with the show will know, these are a more complex form of generic drugs for biologic drugs, which are more complex treatments. Biosimilars are not like your traditional generics because they're not identical, so it's a little bit trickier to evaluate whether or not it actually is a perfect or close-enough-to-perfect substitute for the original therapy. 

The biosimilar approval process has been in place for a lot longer in Europe than it has in the United States. In the U.S., the framework was first enacted in 2009, and the first approval of a biosimilar didn't come until 2015. Meanwhile, across the pond, the first approval was granted in 2006, which is one year after a framework was created for this. So, there are many more biosimilars approved in the E.U. than in the U.S. 

So, while domestically we're still kind of looking at these first few that have been approved and seeing what the trends are in pricing discounts -- because a non-branded drug is going to be cheaper, but the question is, how much cheaper, since it's still a very complex drug -- and, just looking at adoption rates and all the other questions around biosimilars, it can be helpful to look at how things have fared in Europe first.

Campbell: Absolutely. And perhaps their adoption of biosimilars, and that pace of adoption being so much faster than here in the U.S., is due to the fact that they approach medicine with more of a budget focus. I have a fixed pool of money in my country that I can spend on care, therefore if I can decrease the amount I spend on this expensive biologic by instead recommending the use of this biosimilar that's cheaper, that frees up more money for me then to spend on these other new drugs that are coming through and winning approval by the EMA. So, I think there's definitely some differences on that front. 

I believe that biosimilars will eventually gain a foothold here, similar here to what we saw with small molecule drugs. I think we're in the 1990s, if you compare the two, where we are timeline-wise, in biosimilars. And my expectation would be that you'll see biosimilars demand ramp up relatively rapidly over the course of the next five or ten years. But, again, still trailing what we've seen so far in the European Union for sales. That's obviously the most attractive market for the manufacturers of biosimilars to win an OK in right now.

Harjes: Yeah, for sure. Transitioning to the back half of the show, we're going to be digging into the French drug maker, Sanofi, which is listed on the New York Stock Exchange under the ticker SNY. They're a $94 billion market cap company. They pay a heck of a dividend, yielding about 4.6%. And the share price has been beaten pretty badly by the market over the last year or so. They're down 25%. 2017 was widely recognized as a transition year for the company. We'll cover their future plans and weigh in on our opinion of the company's prospects, but first, let's do a little bit of history and get a sense of why they need a transition to begin with.

Campbell: What's interesting, Kristine, about talking about Sanofi and doing the background to prepare for this show, is thinking about how few investors probably own this company in their portfolio. You just reeled off some pretty crazy numbers, $95 billion market cap company with nearly a 5% dividend yield, €35 billion in annual sales, yet not very widely owned relative to some of these other biopharma stocks that we tend to talk about on the show. And perhaps the reason for that is, there's been a lot of concern over the last couple years of how Sanofi would navigate patent expiration, specifically the expiration of patents that protect Lantus, their top-selling diabetes drug, that, prior to losing patent exclusivity, was raking in about $7 billion a year in sales.

Harjes: Yeah. That was a ginormous drug, so there was a lot of concern when it went off patent in 2015. But that wasn't all. They also had Plavix, which was the second-best-selling drug in the world for years, and that lost protection back in 2012. There was also Lovenox, which is a slightly smaller drug, but still, when they lost the patent for that in the late 2000s, it ended up costing them a couple billion dollars in sales annually.

So, management looks at all of these roadblocks up ahead, and they decided that they were going to bring in a new CEO in 2014. Come 2017, they're like, "OK, this is the year we're going to turn things around." They ended up solidifying their focus into five different business units effective January 1st of 2017. Now it's 2018, and we get to look back and see, well, how did that transition year go?

Campbell: I think that most investors would look at it and yawn over the results. If you back out the effects of currency -- and currency, it's a global show today, right? We're talking international stocks today. Probably, Sanofi is one of the most diversified in terms of where it gets its revenue from. It gets more sales in the U.S. than anywhere else, about 34% of its revenue comes from the U.S. But it still gets 27% of its sales in Europe and 29% of its sales in emerging markets. And converting all of that currency back into euros can get kind of expensive. Right now, that's creating some headwinds to the company's progress in improving its revenue. Year over year last year, when all the puts and takes were considered, we're talking about relatively flat growth when you back out the effects of that currency conversion. 

If you look at each of the five business units, some are performing better than others. The way that they broke it out is, they have one group which they refer to as Sanofi Genzyme, that's their oncology and immunology business. Last year, that did about €6.7 billion for sales. That has drugs like multiple sclerosis drugs and rare disease drugs like Pompe disease, hemophilia drugs, which we'll get to in a little bit, that they added with their acquisition of Bioverativ. 

Their second group is Sanofi Pasteur. That did about €5.1 billion in sales last year. The third group is the diabetes and cardiovascular drug business, that did €6.9 billion last year. The consumer business that they have, they're actually in the top three globally in consumer medicine, that did about €4.8 billion in 2017. Then, if you look at the emerging markets business, and what they call general medicines, that's a $14 billion business, with about €10 billion coming from emerging markets.

Harjes: When you look at where this company stands right now, it's pretty clear that they're trying to ignite some growth. And you can tell what their priorities are particularly by looking at how they've spent money on acquisitions recently. They acquired Bioverativ for $11.6 billion in cash. We covered this back in January, on the 24th, if anybody wants to go back and find that episode. This was a very splashy acquisition for a number of reasons. First of all, it was a 64% premium to the prior close. Meanwhile, Bioverativ had just been spun off from Biogen. Something that we questioned on our show was, why didn't Sanofi just go buy it directly from Biogen before the spin-off? Anyway, more of our thoughts on that on the January episode. The point here is that it really solidifies that they are focusing on hemophilia.

Campbell: Yeah. In this big growth market, billions of dollars in sales spent every year on trying to help these people with these bleeding disorders. What Bioverativ has done is created new treatments that reduce patient burden by reducing the number of injections that they have to take per month. Obviously, that's a win for patients, and sales of Alprolix and Eloctate, which are the two drugs that are approved for hemophilia A and B, sales of those drugs have really taken off. If you look at 2017 alone, Bioverativ generated about $1.17 billion in sales, and that was up 32% year over year. 

But that's not the only way that they're trying to refocus and spark some growth back into the company. They also have some intriguing relationships with other companies. Regeneron jumps to mind. The two companies have been collaborating together to create new drugs. They've brought a few to market now. They've brought Praluent, which is a cholesterol-lowering drug, to market. They've also won approval for a drug for eczema and another drug for rheumatoid arthritis. I think that those kinds of collaborations they view as being, for the most part, a win, because it injects some of that growth that can offset some of the headwinds associated with Lantus.

They're also increasing the spending on R&D. I think they increased spending on R&D, I want to say, by 9%, in the high single digits, something like that, to about $5.5 billion last year. Again, that's a good sign, as well, because if you don't have a whole pipeline of drugs, we know that a lot of drugs in pipelines are going to fail, you're going to have to spend more to have that pipeline nice and full so that a few wins come out on the bottom.

Harjes: And they do have a fairly full pipeline. They have 28 different projects that are in Phase III or submitted for approval, and that's across a huge range of different indications. You mentioned partnerships. I want to call out one more, probably just because I have a bias of liking this company, Alnylam. They are an RNAi platform company. They have had a partnership with Sanofi since 2014. Sanofi has full rights now to a drug called Fitusiran, which is a drug for hemophilia, again, and rare bleeding disorders. It had a bit of a hiccup previously with the FDA putting it on hold temporarily, but now it's back and starting up in Phase III. This drug could be a fairly sizable one, at least a billion-dollar blockbuster, many people are anticipating, when and if it gets approved. Alnylam will get royalties on it, but they're in the 15-30% range, so not a huge chunk. Really, a potential win here for Sanofi primarily.

They're also doing some interesting things in digital health. They have a partnership with Verily on something called Onduo, which is a virtual diabetes clinic that's focused on education and disease management. As we know about diabetes, it's a disease that, when not managed well, can really escalate and have a lot of complications. So, the better you can educate patients with the disease and make comprehensive treatment plans for them, the better the outcomes are. 

They're also an investor in Science 37, which is attempting to bring clinical trials into people's homes through telemedicine so you don't have to travel far and wide to get to a clinical trial location. Of course, this is particularly an opportunity in rare diseases, where, as a company running a clinical trial, you might need to be recruiting from far and wide because there just aren't a lot of patients with the disease to study. So, if you can bring that directly to people in their homes, I can see how that would be a really interesting innovation.

Campbell: Yeah. The vast majority of people don't live in those medical clusters, places like Boston, Massachusetts, or wherever, where a lot of these trials are conducted. So, you're right, bringing the trial to the patient, where the patient lives, and letting them continue to receive care by their primary care doctor, is interesting approach that could speed along development for their rare disease business.

Harjes: Yeah. Todd, I know you pulled guidance numbers for 2018. Can you share those?

Campbell: In the first quarter of 2018, they put out their guidance. This is the year they say that they will return to X currency business income growth. That's a mouthful. 2-5%. Whoopee, right? So, this is the year, if you back out all the currency, they think they're going to start earning more money. Then, hopefully from here on out, they'll be able to grow year after year after year using some of these platforms and relationships and acquisitions, leveraging them for sales growth. 

I mean, I think the devil will be in the details. You talked about the Alnylam trial. That was halted for four months because of a patient death. They restarted it after making some concessions in the way that they were monitoring patients. We'll see data from that trial in the second half of 2019. And you're right, that could reshape hemophilia treatment, because again, it reduces patient burden further because that drug is only dosed once per month. 

The company also recently bought a Belgian company called Ablynx for about $4 billion that has a nanobody drug platform. An approval is expected for one of its drugs for rare blood disorder at some point in the near future, too, so we'll have to see how that goes. Then, of course, looking at label expansions, they think that Dupixent, which is their eczema drug, maybe that wins approval in asthma, it could be effective in some other disease indications as well, in autoimmunity. They're also hoping to get the FDA to add some long-term cardiovascular outcome data for their Praluent, which is the cholesterol-busting drug. As a refresher, that drug did demonstrate the ability to reduce heart attacks and stroke within its long-term study. So, that could also provide a catalyst. Those are probably more 2019 issues, though.

Harjes: Yeah. I think, if I were an investor in this company, I would be a lot more optimistic about the label expansions than necessarily the strategy of acquiring other companies. I was fairly surprised to hear about the Ablynx acquisition earlier this year. It seemed like a pretty large amount of pay. I think it was almost $5 billion U.S. dollars for this drug that has an experimental treatment for rare blood disorders. And that was after their very expensive acquisition of Bioverativ. Now, this is a company that has about €15 billion in debt and about €10 billion in cash. So, I don't know, I think I would rather see them focus on their currently owned assets and see what they can do there to generate a little bit more cash before spending even further. But, I also like what they're doing with the partnerships. I do think that's a smart strategy.

Campbell: Yeah. And Kristine, debt is never a good thing, but they were able to get that debt pretty cheap, and they generate enough cash flow, where I'm not really concerned about that, necessarily. But you're right, a lot of times people question whether or not these acquisitions really pay off. Only time will tell on these.

Harjes: Yeah, absolutely. Any final thoughts before we sign off?

Campbell: I think Sanofi is -- I use this word a lot -- an intriguing stock to consider owning. The reason I say that is, because it's a global company, it has big exposure -- it's actually the market share leader in China -- because it has exposure all across the world and it generates a lot of cash flow, I'm not really concerned about its debt. And that dividend, Kristine, that's a pretty nice dividend yield. If they do indeed -- 2017 was the transition year -- in the back half of the year, they deliver on their goal to return to business income growth, I could see putting this into an income portfolio.

Harjes: Yeah. It's kind of a value play. It's been beaten up, which is why that dividend looks so juicy right now. So, yeah, for all the reasons that you just listed, the international exposure and that really solid dividend -- which, by the way, has been increasing for 24 years, so it's a dependable dividend -- I can see those being reasons to be interested in this stock.

One housekeeping note before we sign off, if you're going to be in the Washington DC area on Wednesday, May 30th, we're having a listener meetup happy hour. Shoot me an email at [email protected] for more details.

As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. I'm Kristine Harjes, and on behalf of myself, Austin, and Todd Campbell. Thanks for listening and Fool on!