Pharma Stock Outlook: Let's Make A Deal

Pharmaceutical Stock Outlook: Acquisitions & Deals in Focus

2014 turned out to be one of the most active years in the pharma sector where mergers and acquisitions (M&As) and licensing agreements are concerned. While tax inversion deals were being actively pursued earlier, these cross-border deals lost their luster considering new rules imposed by the Treasury Department.

Deal-Making Frenzy Showing No Signs of Slowing Down

Nevertheless, M&As continue to play a major role in the pharma and biotech sector and are not showing any signs of slowing down. AbbVie's (NYSE:ABBV) $21 billion acquisition agreement with Pharmacyclics Inc (NASDAQ:PCYC) is one of the biggest deals to be announced in recent times. The deal goes to show that lofty valuations will not deter large companies from pursuing acquisitions to boost their pipelines and product portfolios. Other major deals include the ones involving Actavis (NYSE:ACT) – Allergan (NYSE:AGN) , Shire Plc (NASDAQ:SHPG) -NPS Pharmaceuticals, Endo (NASDAQ:ENDP) – Auxilium, and Pfizer (NYSE:PFE) -Hospira (NYSE:HSP). Salix Pharmaceuticals Ltd (NASDAQ:SLXP is currently being wooed by both Valeant Pharmaceuticals (NYSE:VRX) and Endo.

Meanwhile, we expect small bolt-on acquisitions to continue. In-licensing activities and collaborations for the development of pipeline candidates have also increased significantly. Several pharma companies are focusing on in-licensing mid-to-late stage pipeline candidates that look promising, instead of developing a product from scratch, which involves a lot of funds and time.

Small biotech companies are open to such deals - most of these companies find it challenging to raise cash, thereby making it difficult for them to survive and continue with the development of promising pipeline candidates. Therefore, it makes sense for them to seek deals with pharma companies sitting on huge piles of cash.

We recommend biotech stocks that have attractive pipeline candidates or technology that can be used for the development of novel therapeutics. Therapeutic areas attracting a lot of interest include central nervous system disorders, diabetes and immunology/inflammation.

The hepatitis C virus (HCV) market is also attracting a lot of attention. Another lucrative area is immuno-oncology as these therapies have the potential to change the treatment paradigm for cancer -- they basically use the natural capability of the patient's own immune system to fight the cancer. Major players in this field include Bristol-Myers Squibb Company (NYSE:BMY), Astrazeneca Plc (NYSE:AZN), Merck (NYSE:MRK) and Roche Holding Ltd (OTC:RHHBY). Deals targeting immuno-oncology are being inked by companies like Pfizer Inc (NYSE:PFE), Merck KGaA PK (OTC:MKGAY), Bristol-Myers, AstraZeneca and Incyte (NASDAQ:INCY).

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Another trend witnessed recently is the divestment of non-core business segments. Companies like Pfizer, Abbott Laboratories (NYSE:ABT), UCB, Novartis AG (BA:NVS), Glaxosmithkline (NYSE:GSK) and AstraZeneca have all been a part of this trend. The monetization of non-core assets allows these companies to focus on their areas of expertise.

Restructuring activities are also gaining momentum as large pharma companies look to cut costs and streamline operations. Most of these companies like Allergan, Merck, Novartis, Eli Lilly and Company (NYSE:LLY), Shire and Sanofi (PARIS:SASY) are re-evaluating their pipelines and discontinuing programs with an unfavorable risk-benefit profile.

Products with Blockbuster Potential Gain Approval

Several important product approvals as well as label expansions were gained last year. Gilead strengthened its position in the HCV market further with its combination treatment, Harvoni, gaining FDA approval. Harvoni is expected to bring in multi-billion dollar sales for Gilead.

The highly lucrative obesity market got a new player with Orexigen Therapeutics Inc (NASDAQ:OREX) Contrave gaining FDA approval. Meanwhile, it proved to be third time lucky for MannKind Corporation (NASDAQ:MNKD) with the company finally gaining approval for diabetes product, Afrezza.

The FDA also said yes to Celgene (NASDAQ:CELG)’s blockbuster hopeful Otezla and Amgen (NASDAQ:AMGN)’s leukemia drug, Blincyto. Products like Medivation's (NASDAQ:MDVN) Xtandi and Pharmacyclics’ Imbruvica gained label expansions.

Other highly anticipated treatments like Opdivo (metastatic melanoma), Viekira (HCV), Esbriet (idiopathic pulmonary fibrosis), Keytruda (melanoma), Orbactiv and Dalvance (skin infections), and Zydelig (blood cancer) were among the 41 new molecular entities (NMEs) and Biologics License Applications (BLAs) approved last year.

Meanwhile, so far in 2015, the FDA has approved 9 NMEs and BLAs.

Biosimilars Gaining Focus

With the FDA approving the first biosimilar in the U.S. (Zarxio, a biosimilar version of Amgen’s blockbuster drug, Neupogen), the floodgates have opened. While biosimilars have been available in the EU for quite a while, there was no regulatory pathway for biosimilars in the U.S.

Biosimilars should cut healthcare costs and provide a large number of patients with access to much needed biologic treatments. According to information provided by Express Scripts (NASDAQ:ESRX), about $250 billion could be saved in the next decade (2014 – 2024) if biosimilars for 11 products including Neupogen, Avastin, Epogen, Humira, Neulasta, Remicade and Rituxan are approved. According to the company, Neupogen biosimilars alone represent potential savings of about $5.7 billion.

However, at present, there is low visibility on the pricing of biosimilars in the U.S. Unlike generics, which are sometimes priced at even a 90% discount to the branded drug, biosimilars are usually sold at a 20%-30% discount to the price of the reference drug. So, it could be a while before biosimilar sales actually pick up and meet industry expectations.

Apart from Novartis, companies like Merck, Amgen, Hospira (NYSE:HSP), Biogen Idec Inc (NASDAQ:BIIB) and Actavis are targeting the highly lucrative biosimilars market.

Meanwhile, emerging markets remain focus areas with companies like Mylan (NASDAQ:MYL), Pfizer, Merck, Eli Lilly, Glaxo and Sanofi all looking to expand their presence in India, China, Brazil and other emerging markets.

However, while higher demand for medicines, government initiatives for healthcare, new patient population and increasing use of generics should help drive demand, we point out that emerging markets are also not immune to genericization.

Earnings Trends

The Q4 earnings season is over for the medical sector. While the earnings "beat ratio" (percentage of companies coming out with positive surprises) was 81.1%, the revenue "beat ratio" was 69.8%. Total earnings grew 23.9% compared to 15.5% in 3Q, while total revenue grew 11.9% in the quarter compared to 12.1% in 3Q.

Looking at consensus earnings expectations for 1Q, earnings are expected to grow 10.5% and revenues 9%. While results will be affected by negative currency movement, new products should start contributing significantly to results and increased pipeline visibility and appropriate utilization of cash should increase confidence in the sector.

Overall, 2015 earnings are expected to grow 9.7% and revenues 9.6%. For a detailed look at the earnings outlook for the Medical and other sectors, please check our Original post

Written By: Zacks Investment Research