4 Pharma Stocks Gaining From High Pricing Power
Presidential candidate and Democratic party front-runner Hillary Clinton’s comments on the prohibitive costs of certain medications have recently drawn much attention. Most of these exorbitant prices have been attributed to new launches or sudden price hikes. However, a new study by the Wall Street Journal shows that higher revenue generated by pharma companies is primarily attributable to a series of price increases.
In fact, companies exert pricing power to such a degree that even falling demand can be countered. Several other factors are responsible for such price increases besides patent protection. This is why pharma companies are likely to gain from this phenomenon even in the future and it may be a good idea to add such stocks to your portfolio.
Higher Prices Negate Falling Demand
The study covered 30 of the top selling prescription drugs using financial statements and prescription data from IMS Health Holdings, Inc. (IMS - Snapshot Report) and wholesale prices from Truven Health Analytics. The period covered stretched from the beginning of 2010 to the end of last year.
The key finding was that growth in revenues had clearly beaten demand levels during this five year period. Average revenue growth came in at 61%, nearly three times higher than the growth in prescriptions. This was primarily achieved by a series of price increases.
Overall, wholesale prices have increased 76% over the five year period covered by the study. This is eight times higher than inflation levels. Of the 30 drugs covered, 18 have experienced increases in both prescriptions and revenue. But in each case, revenue has increased at a significantly faster pace than prescriptions. In fact, 10 drugs have generated revenue increases even though demand has fallen.
For instance, the price of Novartis AG’s (NVS - Analyst Report) Gleevec experienced a 2% increase in prescriptions over the period. However, the wholesale price increased by more than 100%. Consequently, revenues from Gleevec increased 69% in the 2010-14 period.
Origins of Pricing Power
Raising prices helps to combat falling demand, the lack of new offerings and competition. Recent price increases strike a stark contrast to the 2007-13 period when expenditure on prescription drugs increased only 2.7%. This was primarily due to widespread usage of generics following the loss of patent protection for several popular drugs.
However, this effect seems to have abated. According to CVS Health Corporation (CVS - Analyst Report), expenditure on drugs increased 12.7% last year, three times the increase recorded in 2013. This means that patent protection is responsible for some of the pricing power.
But there are other reasons which allow pharma companies to raise prices. One of them is the fact that the U.S. health system is based on insurance. This means that patients do not have to face the impact of a price hike. Nor are doctors concerned about the price of drugs while prescribing them. This reduces the tendency of higher prices to dampen demand from the consumer side.
Additionally, loyalty is built up when a consumer experiences beneficial effects from a drug over a long period. This means that neither doctors nor patients are eager to switch to newer drugs when they are satisfied with the effects of a drug being used over a long period.
Price Hikes Fuel Research
Pharma companies argue that revenues generated from higher prices are utilized for drug development. This is an exercise which involves high levels of cost and risk for companies. It would be difficult to attract investment for such an activity without the promise of high levels of returns. For instance, Biogen Inc. (BIIB - Analyst Report) has spent nearly $1.19 billion on an average every year on drug development. This adds up to 24% of its total revenue.
Additionally, the overall benefit to the economy in reducing costs of health care is often ignored. This is because the drugs often prevent new complications arising out of existing diseases. Also, pharma companies offer large rebates on wholesale or list prices on to the likes of insurance companies and pharmacy benefit managers.
Our Choices
Several of these drug’s prices will possibly fall when their generic versions become available. However, it is clear that there are several other reasons for the high levels of pricing power pharma companies enjoy and their effects are expected to last over a significantly long period.
This is why it may be a good idea to invest in companies which are generating higher revenues though price increases. We have narrowed down our search based on good Zacks Rank and other relevant metrics.
Amgen Inc. (AMGN - Analyst Report) is one of the leading biotechnology companies in the world, with extensive manufacturing, distribution and sales facilities.
The company’s drug Enbrel has experienced growth in revenues of 33% over the five year period covered by the study even though prescriptions have increased only 2%.
Amgen has a Zacks Rank #1 (Strong Buy) and projected growth for the current year is 12.1%. The forward price-to-earnings ratio (P/E) for the current financial year (F1) is 14.41. It has a PEG ratio of 1.54, lower than the industry average of 1.67.
Eli Lilly and Company (LLY - Analyst Report) is a global healthcare company with core products in a number of primary-care pharmaceutical markets.
The company’s drug Cialis has experienced growth in revenues of a 58% over the five year period covered by the study even though prescriptions have increased only 9%.
Eli Lilly has a Zacks Rank #1 (Strong Buy) and projected growth for the current year is 18.1%. It has a PEG ratio of 1.88, lower than the industry average of 2.01.
AbbVie Inc. (ABBV - Analyst Report) is a biopharmaceutical company which focuses on the development and marketing of treatments for complex and serious ailments.
The company’s drug Humira has experienced growth in revenues of 127% over the period covered by the study even though prescriptions have increased by 49%.
AbbVie has a Zacks Rank #2 (Buy) and projected growth for the current year is 28.5%. It has a P/E (F1) of 13.08 and a PEG ratio of 0.90, lower than the industry average of 2.01.
Teva Pharmaceutical Industries Ltd. (TEVA - Analyst Report) is a global pharmaceutical company that develops, manufactures, and markets both branded and generic drugs, as well as active pharmaceutical ingredients (APIs).
The company’s drug Copaxone has experienced growth in revenues of 36% over the period covered by the study even though prescriptions have declined by 5%.
Teva has a Zacks Rank #2 (Buy) and projected growth for the current year is 4.7%. It has a P/E (F1) of 11.02, lower than the industry average of 16.65. The company’s earnings estimate for the current year has increased 0.6% over the last 60 days.
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