Slimming drugs brighten up a dull pharmaceutical sector

The global healthcare sector overall has been performing badly, leading some to ask if whether this provides a good opportunity to buy into the sector. In contrast, a couple of major companies have seen their share price soar this year as they develop anti-obesity drugs.

| 10 min read

Eli Lilly and Novo Nordisk have caught the mood with their products, helping more people to slim down. Many countries face a widespread obesity problem, with related medical difficulties including diabetes compounding the issue.

There is a ready outlet and plenty of excitement when a company announces a new way to help people cut their weight. As a result of this pattern, there is wide divergence in share price actions within the narrowly-defined pharmaceutical sector, as well as within the wider healthcare sector which includes medical equipment, biotechnology and digital assistance to medical care.

The nature of the index and sector

The sector, as measured by the MSCI World Health Care index constitutes 72% US-listed companies, 7% in Switzerland, 5% in Denmark and 4% in Japan. The top 10 companies include six US ones, two Swiss ones, a Danish and a UK group. In total, 40% of the market capitalisation comes from the traditional business of researching new compounds for drugs, gaining regulatory approval, registering a patent – and seeking good margins all the time the medicines are patent-protected.

As with the digital sector, the US is in a dominant position with a large domestic market and worldwide opportunities to sell its treatments. When they go off patent there is generic competition serving to lower prices and margins. The length of the patent is usually 20 years from registration, before approved release of the drug. It is designed to allow a company to recoup the development costs of the treatment, which can be considerable. Not all trial compounds result in safe, patented drugs being brought to market.

Another 15% of the index is in healthcare equipment manufacture and 14% in biotechnology. There is also an increasing role for digital technology and artificial intelligence (AI) in assisting medical professionals, keeping patient records and providing data to improve diagnosis and choice of treatment.

The leading drug companies – which represent 42% of the index – have, on the whole, performed badly over the last two years. Whilst they fell considerably less than the general index in 2022, this year they have underperformed – with the index 19% below the general world index. In 2022, the general index declines were based on monetary tightening and higher interest rates whilst pharmaceutical sales were thought to be more reliable and boosted by vaccines and drugs against Covid-19.

This year, they have underperformed badly with the exception of Eli Lilly and Novo. Moderna, the company specialising in mRNA vaccines which shot to prominence in 2021 as an answer to Covid-19, has seen a further share price collapse. Its share price is now down by more than 80% from its peak.

The battles over drug pricing

Many of the drugs for sale are sold to government-run systems such as Medicare and Medicaid in the US and government-run systems in Europe. Other drugs are sold to healthcare practitioners where governments may still take an interest in the prices of the drugs. In the US, both the Democrats and Republicans are keen to be on the side of patients and regularly review ways to curb price rises and stop margin increases. Traditionally the US has avoided direct government control of prices, whilst many European health systems do have some price controls. As a result, US patients pay much higher overall prices for drugs.

There is risk of further political intervention against company profits in the run up to the presidential election..

The US manufacturers argue that they need higher prices and margins to generate the cash to commit to new discoveries and product development. The US, partly as a result of this freer system, is home to the world’s largest pharmaceutical industry, creating the most new drugs. Many US citizens take prescription drugs and find the costs high. More elderly voters in particular are worried by drug costs. This year there will be around 5 billion retail prescriptions issued in the US.

There is risk of further political intervention against company profits in the run-up to the presidential election. President Joe Biden has declared himself as the fighter for lower drug prices. He calls the current high prices in the US compared to the rest of the world “outrageous”.

In the US there has been a drift towards price controls. Medicare and Medicaid now include ceiling prices whilst encouraging more use of generics. The President has through the Inflation Reduction Act introduced a system of price controls, with 10 drugs identified so far for this treatment with another 40 promised by 2029. The Biden administration unveiled the first 10 drugs subject to Medicare price negotiations. These drugs are listed below:

Source: Centers for Medicare & Medicaid Services, Department of Health and Human Services.
Credit: Rachana Pradhan/KFF Health News.

Some companies have launched legal challenges to these moves and have repeated their view that higher prices are essential to drug development.

Most countries with a state-run system of healthcare use some form of approved drug list and some negotiated price for the drugs. The emerging world looks to the leading advanced country pharmaceutical companies to provide better value medicines from their lists. There is, however, a general understanding that higher prices and better margins are needed to signal the wish and provide the money to research new drugs, and general support for a patent system which allows this. State-run systems seek to balance the need to keep some pharmaceutical business activity in their countries with the need to keep some control over the costs of drugs.

Health systems promote and support the development of generic alternatives to an expensive branded drug as soon as the patents allow. Some state systems can negotiate lower prices for drugs they confine to use in their own domestic systems. There are also periodic reviews of how many drugs are being prescribed, with some arguing that a health care system may tend to overprescribe, as doctors are not usually under any pressure to avoid prescribing and many patients expect to exit the surgery with a pill.

Patent run-off and competitive threats

The fortunes of individual drug companies are tied up with the balance in their drug portfolio between older drugs approaching the end of patent life and new drugs coming on stream. Shares can perform very well – as we have seen this year with Eli Lilly – when a company tackles an important area of demand like obesity with new products that offer a great deal to users and the company.

Shares can suffer if a company has too many failures to get a product development through regulatory approvals and into the market or if it sees too many drugs lose patent protection. A company can also suffer if it faces damaging lawsuits over products it has sold, where some patients or medics think the product did not work well or was not safe enough. A pharmaceutical company is exposed to serious risks as its products intervene with many sick patients sometimes leading to disputes over the results.

The wider sector is benefitting from the application of more digital processing power, data storage and use. A medic gaining access to a large number of back records defining a condition and cataloguing the results of various types of treatment can empower the user. A doctor who has only seen a few cases of a medical condition can gain access to large numbers of back histories to guide understanding of the problem and the likely results of different drug and surgery treatments. The AI assistant can be at the medic’s side to augment their capability.

There is also demand for better systems of logging and filing data on patients, for booking appointments, supervising drug regimes and assessing results. Digital controls of machines and monitors can assist with direct interventions in a patient.

India has become a large producer of generic medicines, reproducing products that have gone out of patent. It also produces a lot of vaccines for export. The major advanced country pharmaceutical companies are sometimes willing to provide cheaper versions of their medicines to the world’s lowest-income countries, and they sometimes collaborate with Indian generic producers to do so. Generic medicines dominate the volumes of drugs sold, whilst patented medicines drive the profits of the major pharma companies.

The case for rising demand

As income rises in an economy, demand for drugs increases as more can afford them. There also becomes more need for treatments for the problems of affluence. The ageing of populations with more people living longer and fewer live births relative to the population also boosts demand for drugs, as people tend to need more drugs in old age, with their demands on medical services often concentrated on their last few years of life. Health systems and governments battle to try to keep the growth in prescriptions under some control.

There are good investment opportunities within the growing medical sector. Most growth is likely to be concentrated in harnessing digital technology to the tasks of diagnosing and treating patients. Individual drug companies can do well as we have seen this year with the two that are advancing rapidly with obesity treatments. Other companies can lose out through a sharp decline in demand as with Covid-19 vaccines, or with loss of patent protection for important drugs, or from failure to bring forward sufficient good new product.

Buying and holding the sector as a whole has not worked well. More companies are now at share price levels where buyers will be attracted by any signs of recovery in sales and profits. Traditional pharmaceutical companies remain at risk of more price controls and generic competition but can offset this with wonder drugs that catch the need and mood of the moment.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Slimming drugs brighten up a dull pharmaceutical sector

Read this next

Bonds and Fixed Income sector investment review

See more Insights

More insights

US sanctions and Russia's foreign policy battle it out
By Charles Stanley
26 Feb 2024 | 9 min read
How should you invest during a recession?
By Rob Morgan
Spokesperson & Chief Analyst
22 Feb 2024 | 12 min read
UK recession already over?
By Garry White
Chief Investment Commentator
22 Feb 2024 | 7 min read
Changes of government can affect investment strategy
By Charles Stanley
22 Feb 2024 | 7 min read