IBI bullish on big pharma in 2017

Teva  photo: PR
Teva photo: PR

Analyst Steven Tepper provides a "Buy" recommendation for Teva in the long term.

"With the US elections behind us and Donald Trump with a Republican majority in the House of Representatives and the Senate, all of Hillary Clinton's plans for restraining drug prices have gone down the drain," IBI Investment House analyst Steven Tepper writes in an end-of-year special review of the pharma market, with a focus on generic companies and the upcoming financial reports by companies in the US.

Although President-elect Donald Trump said several times that he intended to restrain drug prices, Tepper believes that he is not as determined as Clinton, and that no tough measures can be expected. "He will find it difficult to act in opposition to the Republican majority in the Senate and the House of Representatives, which opposes any regulation of drug prices on principle."

Because of this, Tepper expects an upward correction in the pharma market. "Over the past 18 months, the pharma sector, especially the generic sector, has underperformed (a 23% drop in the DRG Index, compared with a 4.4% rise in the S&P 500 Index)," Tepper adds. "I expect a correction in 2017, especially in the battered generic sector, which will return share prices to the ranges of multiples reflecting their economic value."

Tepper bases his thesis on the idea that in a world focusing on reducing drug prices, generic drugs are the solution, not the problem. "The generic drug sector is competitive, with moderate and rational prices reflecting the specific extent of competition for each product," he argues. "In 2014, generic drugs accounted for 88% of all the prescriptions issued, but barely a third of the monetary cost of the drugs. The cost of an average ethical drug prescription is 19 times as much as the cost of a prescription for a generic drug."

Generic drugs are cheaper

Tepper admits that there are also failures in generic drug prices resulting from the burdensome regulation governing quality in the US, in contrast to the burdensome regulation on prices in European countries and elsewhere, which make generic drugs more expensive in the US than in the rest of the world. It is still worthwhile, however, for the payer (frequently the government) to prefer generic to ethical drugs. Over a decade (2005-2014), generic drugs saved the US health system $1.7 trillion, with the saving growing year by year.

Although Democratic Party politicians in the US cite studies indicating that drug prices in the generic sector are rising strongly, too, there are also studies that refute this argument. The Generic Pharmaceutical Association claims that on the average, generic drug prices are falling, and also fell 4% in 2014. According to the Association, 73% of generic drugs are cheaper than in the past, even though a limited number of drugs whose prices rise significantly is enough to give the impression of a general rise in prices.

The US Department of Health and Services (HHS) also found that the average manufacturer price (AMP) in real terms rose for only 22% of the 200 drugs with the highest Medicare sales in 2005-2014.

How to increase prices

Tepper says that in order to understand where the generic market is headed, it is necessary to ask whether regulatory intervention in the sector is necessary, and whether such intervention serves any purpose. It is necessary to ask when price increases occur in the generic sector, and Tepper cites a number of examples:

1. Mergers and acquisitions reduce competition, but Tepper says that even in these cases, the increase is not dramatic.

2. A shortage of drugs as a result of problems involving production, quality, and burdensome regulation - this dynamic enables competing companies to exploit the situation by raising prices. Higher prices make it harder for the consumers, but also encourage the manufacturers to produce the drugs in short supply. Any attempt by the regulator to interfere in the process is liable to perpetuate the shortage and encourage the entry of drugs with poorer quality.

3. The drug market features inelastic demand and dispersal of customers, which enable drug manufacturers to make substantial price increases even if there is competition. A rule of thumb is that at least 3-4 competitors are necessary in order for prices to be competitive. Competition should therefore be encouraged by expediting the approval process for these drugs; the companies should certainly not be strangled.

4. Agreements between companies reduce competition for certain products. This is an improper practice. It is usually illegal, and the regulator has the means to prevent it.

Tepper says that there is therefore no need for regulation of generic drugs, and that Trump probably does not intend to impose it.

Tax cuts: Good news for pharma

Trump has also declared that he would eliminate the Obama's health care plan enacted in recent years. In Tepper's opinion, however, it is doubtful whether he will make any extreme changes in it. Even if he changes parts of it, no substantial effect on pharma companies is expected.

Who will be affected? In the short term, due to the uncertainty about Medicare, a negative effect is expected, mostly on medical service providers, such as hospitals. Also in the short term, companies dealing in medical devices and medical information systems are expected to suffer direct damage from the freeze. In the long term, on the other hand, companies with high-quality medical technologies that reduce the overall cost of treating patients will continue to be attractive.

The deep cut in corporate tax from 35% to 15% advocated by Trump is expected to have a positive effective mainly on companies in the US, and less on companies that have succeeded in evading this tax (such as Perrigo Company (NYSE:PRGO; TASE:PRGO), which became an Irish company following a merger) and pay lower tax rates. In addition, companies will have an incentive to bring home profits registered out of the country, and to produce more current profit in the US.

It can be assumed that mergers and acquisitions will speed up with the return of capital from other countries, while companies located in countries with low tax rates that previously derived economic value merely by being tax shelters will be much less attractive.

In general, the health sector appears to be a long-term investment opportunity, due to rising demand, an aging population, and continued growth in the insured population. It will very difficult to stop this process.

Concerning Teva Pharmaceutical Industries Ltd. (NYSE: TEVA; TASE: TEVA), Mylan N.V. (Nasdaq: MYL; TASE: MYL), and Perrigo, Tepper says, "The Teva share is being traded at a very low multiple of 6.2 on its 2017 profit forecast. We recommend 'Buy' for Teva in the long term, while taking advantage of the steep fall in the share price and taking a short-term risk. The falls reflect a loss of confidence by the capital market in the company's management, an excessively pessimistic scenario for generic business, and the possibility that Copaxone sales will plunge in early 2017.

"We believe that the market is not pricing the transformation that Teva is undergoing with the acquisition of Actavis, the competitors' difficulty in obtaining US Food and Drug Administration (FDA) approval for a generic version of Copaxone, and the company's backlog of unique drugs, which are slated to be ready in 2017.

"At the company's current low point, it is liable to become an acquisition target, obviously at a substantial premium on its current value. The rumors of a potential buyer are also likely to encourage the share."

Commenting on Mylan, Tepper writes, "With the Epipen affair over and done with, we are left with a leading generic company having a 6.6 multiple. Following the election of Trump with a Republican Congressional majority, the threat of drug price regulation has been removed. We reiterate our 'Buy' recommendation for Mylan, which is traded at a 6.6 multiple on its projected 2017 profit."

Perrigo, on the other hand, excluding the Tysabri royalties asset, is traded at a high 15.5 multiple. Tepper writes, "It is showing weakness in all of its core business, especially in generic prescription drugs and over-the-counter health brands (Omega). The company lowered its share-adjusted profit forecasts by a cumulative 28% in 2016. The variety of actions taken by the company to stabilize its situation will take time to work, and we still see no horizon for a return to growth."

Published by Globes [online], Israel business news - www.globes-online.com - on December 14, 2016

© Copyright of Globes Publisher Itonut (1983) Ltd. 2016

Teva  photo: PR
Teva photo: PR
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