A Look Back At The Year In Pharmaceuticals

By Stephen D. Simpson, CFA | December 15, 2012 AAA

As a group, 2012 has been a middling year for the pharmaceutical sector. Against a roughly 13% year-to-date gain in the S&P 500, the S&P Pharmaceuticals ETF (ARCA:XPH) is up only about 8%. Companies in the pharmaceutical space continue to face heavy pressure to their revenue as key drugs have gone off-patent and many companies have struggled to develop new blockbusters to pick up the slack. Instead, many companies have focused on cost-cutting as a means of improving results and investors seem to be relatively skeptical about the near-term growth potential of the sector.

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Revenue Matters
Drug stocks are often talked about as being reliable growers in good times and bad, but the last few years have shown that to be largely an old wives' tale. Although it's true that drug stocks are not necessarily economically sensitive, the cycle of blockbuster approvals and patent expirations does create company-specific volatility in results.

Many of the top performers in the drug space this year stand out for their relatively better revenue growth performance. Denmark's Novo-Nordisk (NYSE:NVO) continues to ring up sales with its insulins and diabetes medications, and its 10% revenue growth for 2012 places it as one of the best growers in the space. Perhaps not surprisingly, then, it's also a top stock performer in the industry, with shares up about 40% this year.

France's Sanofi (NYSE:SNY) has also been a strong performer, with the shares up nearly 30%. Although Sanofi's revenue performance has not been objectively great (revenue is likely to decline slightly for 2012 on a reported basis), the company is emerging from the worst of its patent-related sales declines and management has moved decisively to cut costs, streamline the business and establish a path towards a more consistent future growth by relying less upon blockbusters.

SEE: Evaluating A Company's Management

The Weak Hands Lag
If outperformance in the drug sector in 2012 can be tied to above-average revenue performance, it stands to reason that the laggards in revenue growth would be among the worst performers. This has not proved to be entirely true, but it is clear that investors have avoided stocks with weak near-term prospects.

AstraZeneca (NYSE:AZN) is arguably one of the weakest near-term stories in the sector, and the stock has struggled to show any gains for the year so far. AstraZeneca has seen a one-two punch of losing major drugs to patent expirations and also seeing major clinical trial disappointments. This has left the company scrambling to refill its pipeline and turning to deals to improve its prospects.

AstraZeneca's partner in diabetes care, Bristol-Myers Squibb (NYSE:BMY) has seen similar problems and the stock's weakness this year (down nearly 10%) reflects them. Bristol-Myers has seen some significant setbacks in 2012, as its acquisition of Inhibitex for hepatitis C has gone horribly wrong and the prospects for anticoagulant Eliquis doesn't seem to be as bright as they were a year ago. Bristol-Myers has made some large, highly focused bets for future growth - investing considerable sums into its oncology pipeline and acquiring diabetes drug specialist Amylin Pharmaceuticals - but it looks like it's going to take at least another year or two for the company to return to growth.

Every rule has some exceptions, and that's true for the revenue growth - stock price linkage as well. Although Forest Labs (NYSE:FRX) is seeing revenue wilt in the face of major patent expirations, the stock is up 14% on increasing optimism regarding its pipeline and recent new drug launches. Likewise, while Pfizer's (NYSE:PFE) revenue is likely to decline by double digits this year, the stock is up more than 15% on positive pipeline developments and management's efforts to streamline the business (including the disposals of the infant nutrition and animal health businesses).

SEE: Pharmaceutical Phenoms: America's Best Selling Medicines

The Bottom Line
While there are growing debates regarding the hefty price tags of new medications (particularly in oncology), for now at least it still looks as though drug companies can translate solid clinical trial data into robust prices. Not surprisingly, that puts a premium on those companies with a demonstrated ability to produce a steady stream of innovative new drugs.

In most respects, 2013 will likely resemble 2012. Companies with solid near-term launch pipelines and/or solidly growing major drugs will likely continue to enjoy Wall Street's favor, while those with sparse launch prospects and/or significant clinical setbacks will likely see their stock prices suffer.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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