35-20 Pharmaceuticals & Biotechnology 2006F ... - Marriott School

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Dec 1, 2012 (4 years and 9 months ago)

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BM 416, Fall 2006, Analyst: Mark Duroy
markduroy@yahoo.com


September 2006

Pharmaceuticals

& Biotechnology

United States

Industry Type

(
9/15
/06) High Growth

Key Indices:


S5PHRM

Recommendation:

Hold





D
escription and Summary:

The pharmaceut
ical industry consists of brand
-
name
,
generic and

over
-
the
-
counter drug makers.
Companies
become

leaders by spending

on R&D in ord
er to find

a
breakthrough drug
.

Drug manufacturing is high
-
risk,
and less than one th
ird of drugs are successful enough
to recover
the R&D investment.
Because
pha
rmaceuticals are patented for
20 years, companies
need to continually find new drugs
. Drug product life
nearly always follows the same pattern: 10
-
years of
discovery,

testing, a
nd FDA approval, after which

a
brand
-
name prescription drug will have another 10
years of commercial life.


Biotechnology refers to science
that is used
for the
purpose of modifying human health, food supplies, or
the environment. The biotechnology industr
y focuses
on several practices, some of which involve the
alteration of genetic material.


International Competitive Structure:

The U
S

has the highest market share in the
pharmaceutical industry. Europe is second and Japan
third as these areas have
add
itional

government
regulations.

US drug companies often suffer from lack
of patent protection in developing countries while
European and Japanese
brand
-
name

drugs are priced
only slightly higher than generics.
Asia and Latin
Ame
rica contributed the most
to

growth in 2005.

While
the US

ha
s the largest market, their
industry growth
declined from 60% in 2003 to 40% in 2005.


US companies

get close to 1/2 of their

sales from
foreign
customers. They carefully monitor fluctuations
in the value of the dollar co
mpared with foreign
currencies.

When the dollar is weak, drug

sales and
earnings
increase
.


While the dollar decline
d

agains
t the
euro in 2002
-
2004, it
was

up

for most of 2005.


Strengths:

1
. US government spending is up.
The new Medicare
prescription

dr
ug benefit

make
s

the government the
largest buyer of prescription drugs. T
he portion of
prescription drugs paid for by Medicare will go from
2% in 2005 to 28% in 2006.

Governments worldwide
are increasing spending for vaccinations against
diseases like a
vian flu.


2
. Demographics are good for

pharmaceutical
s. T
he
population
is ageing
in the largest markets
. The number
of elderly is growing faster t
han the general population.
A
verage life expectancy

is getting longer. Chronic
disease is rising.


W
eaknesses:

1.

Competition from generics has a large impact

on the
brand
-
name drug companies
.

Brand
-
name drug
companies are experiencing slow growth in earnings
and revenues
because of generic competition.
Over the
next four years at least 70 brand
-
name
drugs will go off
patent; 19 of those drugs are blockbusters (annual sales
of more than $1 billion).


2.

New drug launches were rare

in 2005, a
nd the
companies facing
pate
nt expirations do not have

replacements
. FDA a
pprovals

may be

more promising
in 200
6, but they are still below the levels needed to
make up the shortfall.
Additionally
, new drugs take
time to build market share.


3.
Although

pharmaceutical sales continue to grow
faster than most segments of the world economy, the
indust
ry decelerated in

2005. Future growth

will
continue to decelerate

and

is not expected to be as fast
as

it has been

over the last 10 years.


Opportunities/Trends:

1.
Biotechn
ology is the fastest growing
sector of the
p
harmaceutical industry.

Biotechnology
contributed
21%

of the pharmaceutical industr
y’s total growth in
2005.


2
.
Pharmaceutical and biotech industry

executives see a
major opportunity in emerging markets, particularly
India and China
.
Most

believe

that

compa
nies

may

do
uble sales
there
by 2011.


3. Generi
c drug companies are doing well. Brand
-
name drug companies are tendi
ng to settle
patent
challenge
cases out of court. These settlements
typically include 180 day exclusive rights to make the
generic version of a drug.

Brand
-
name drug companies
fight thi
s trend by

making their own generics.


Threats:

1.
The new Medic
are prescription drug benefit is off to
a slow

start.
The main

reason
seems to be the

compl
exity of the available choices for seniors. M
any
have delayed signing up due to difficulty in de
termining
whether a particular plan covers the drugs they need
.


2.
For most US pharmaceutical c
ompanies, generics
represent the
main

n
ear
-
term threat to performance.
As
major drugs lose patent protection, intense competition
from

generic

drug makers
and

price erosion are
unavoidable.


3
.
Biotech companies are dependent on FDA approval
and there is a trend toward government price controls.
The timing of new products could affect revenue
growth.


Key Valuation Ratios to Watch:

Be sure to watch
R&D as a p
ercent of sales and relative
P/E

ratios

vs. the
S&P 500 and
industry

P/E ratios
.


Key Items to Watch:

Trend
s in sales growth and R&D

expenses are
important items to watch.

Also watch government
Medicare spending.


R
eturn Performance versus the S&P 500 (
in %)
:




01


02

03


04


05


6YTD

S
5PHRM

-
13.8

-
20.0

10.5

-
5.2

0.2

11.1

SPX


-
11.9


-
22.0

28.4

10.7


4.8


7.2

Excess
-
1.9





2.0
-
17.9
-
15.9

-
4.
6

3.9

GDP 0.8


1.9 2.7

4.2


3.5

1.2est

Sources: Yahoo Finance, MSN Money,
NetAdvantage,

Bloomberg