It is easy to see the demographic attractions of the pharmaceutical sector.
Ageing populations in the west along with increasing wealth in emerging markets mean that the demand for pharmaceutical products is still very strong.
The stockmarket fell out of love with the sector, as companies’ multi-billion dollar-revenue earning drugs were set to come off patent and their R&D budgets were showing little or no signs of delivering any replacements. The chart below shows the consequences of this fall from favour, with the two UK large caps now offering a significant yield premium to that of the market.
The pharmaceutical sector currently represents a major position in the portfolios I manage, which hold both AstraZeneca and GlaxoSmithKline along with some overseas stocks and a range of smaller UK listed companies.
In addition to the income attractions of the sector, one reason I have become more positive on its outlook is that the Food and Drug Administration now appears to be much less restrictive in terms of awarding licences to new products coming through than it was 10 years ago. There are a variety of explanations for this, including more selective targeting by the drug companies.
This may reduce the likelihood of a block buster drug, but approval for a limited range of indications can be more easily approved and still re-fill the pipeline and fuel profitable growth. The FDA is also now involved earlier with the approval process and works with the companies during this. This has expedited the approval of drugs.
Another significant development within the industry has been the technology changes that have been driven off the mapping of the human genome. This occurred in the late 90s, and it has taken 10 to 15 years for the industry to create products that are driven off biological research rather than chemical research.
Biological research, to my mind, is where the entire industry is now moving. There is a significant amount of evidence that personalised medicine will be a major feature in the future, and that should play into the hands of the drug companies in terms of success from pipelines. This has also helped companies with FDA approval, as the drugs are able to be better targeted.
The oncology sector is one showing some particularly interesting drug developments on the back of biological research. A colleague of mine at Invesco recently attended an industry conference in the US.
He reported back that familiar themes of emerging market growth and the impact of ‘Obamacare’ were all touched upon, but the most tangible excitement was in oncology, where there was growing interest amongst investors and companies alike over recent early-stage advances in immuno-oncology.
In fact, many regard these advances as the first real chance to convert cancer from a killer disease into a manageable one with comparisons being made to the treatment of AIDS/HIV. Such claims should always be treated with caution, but so far the science is very eye-catching.
Immuno-oncology is a new approach to tackling cancer. Historically, cancer treatments have been focused on destroying or shrinking tumours in the body through the use of highly toxic agents or radiotherapy, effectively tackling the outcome of cancer. Immuno-oncology is an attempt to tackle one of the biological loop-holes that allows cancer to occur, effectively trying to cut the disease at source.
More specifically, cancer occurs, in part, because tumours have adapted ways to avoid detection by the body’s immune system. Immuno-oncology seeks to unmask the tumours and allow the body’s natural defences to take action against the disease, which if it works will mean that the body can defend against the cancer well beyond the initial treatment phase.
One company that is positioning itself to benefit from developments in immuno-oncology, particularly in the area of combination therapy, is AZN. AZN admits it is still well behind Bristol-Myers Squibb here and reckons that it will take over a year to catch up. It also cautions that there are still “lots of unanswered questions” around this field.
However, AZN has one drug in Phase I of approval, AXD9291, which it hopes to receive accelerated passage straight to stage III and believes that combining AXD9291 with other drugs in its portfolio could prove to be a “transformational therapy” for lung cancer.
How much is this improved news and prospects is already discounted by the stock market? Immuno-oncology, for example, has certainly not gone unnoticed and BMS, the acknowledged leader in immuno-oncology with the fullest pipeline of drugs in this class, has seen its price earnings ratio expand from the high-teens in 2012 to the current forward multiple of nearly 30 times – despite a consistent decline in earnings expectations for 2014 and 2015.
For the companies in the portfolios that I manage, I believe the powerful demographic story and improved regulatory environment and drug pipelines, allied to strong cash flows, will underpin future dividend growth from the sector.
Mark Barnett is a fund manager at Invesco Perpetual