Holly Cook: For Morningstar, I'm Holly Cook. I'm joined today by Damien Conover. He's Associate Director of Healthcare Research with Morningstar. Damien, thanks very much for joining me.
Damien Conover: Thanks for having me.
Cook: So, let's just talk about the healthcare and pharmaceutical sector, what are the some of the key challenges facing the industry at the moment?
Conover: I think the biggest challenge that's facing the big pharmaceutical industry is this patent cliff, and I think a lot of people are familiar with it but we're basically facing massive, massive drugs that are losing their patent exclusivity. So, we're talking about a huge cliff of these really well-known drugs like LIPITORS, like Praxa, these are multi-billion-dollar drugs and a lot of these drugs are losing their exclusivity over the next three years. So this industry, which had been growing reasonably well over the last few years, is now going to face a period that you potentially could see some declines in earnings for specific companies. This is the major headwind that's facing almost all the big pharmaceutical companies.
Cook: So, I think we're familiar with that a little in U.K. when it comes to AstraZeneca, to GlaxoSmithKline for example, but if that's the situation in the developed markets, what's going on in the developing markets?
Conover: Yes. So what's interesting is this is a patent cliff that's really pertaining to the developed markets like the U.S., Western Europe, Japan, but what's interesting, one of the strategies that the big pharmaceutical firms are employing is utilising more resources to sell products in emerging markets, and the patent situation in emerging markets is different than it is in developed markets. For example, the brand is very critical in emerging markets whereas the patent isn't as important. So, as we see sales decline in the developed markets, these emerging markets sales should grow pretty rapidly. So, the real growth potential for these big pharmaceutical firms over the next five years is the emerging market. Now, the headwinds are probably still going to be stronger in the developed markets, but still there is this mitigating factor that's important in the emerging markets that should really help the big pharmaceutical firms.
Cook: And so for those companies that perhaps are looking to come and tap into that market there, are there any particular challenges that come with operating in emerging markets?
Conover: I think there are. I mean, even though the growth potential is pretty robust in emerging markets, you still have a lot of challenges in that. These sort of markets they are new, there's a lot of volatility with them, the patent laws eve—though patents aren't as important in emerging markets—they still have some importance and these laws aren't as concrete as they are in the developed market. So, I think there's a lot more volatility that's going to be seen in the emerging markets, some of the challenges with patent protection, I think both of those things are some headwinds, and so I think we're going to see a few mis-steps, but overall the trajectory should be pretty solid in the emerging markets.
Cook: So for the – let's say look at the European sector, some of your favourite plays, are they companies that are looking to make the most of that emerging markets exposure or are there other issues going on there?
Conover: I think they are. I think the – it's interesting, when we take a look at the big pharmaceutical industry, I think one of the biggest differences between the European big pharmaceutical firms and the U.S. big pharmaceutical firms is the exposure to emerging markets, meaning, most of the European firms are more exposed to emerging markets than the U.S. firms, and I think that's going to benefit the European firms more than the U.S. firms, because as we were just talking about these emerging markets are huge avenues for growth. So, I'd say a lot of the firms in the European big pharmaceutical industry are much more exposed to the emerging markets. In particular, Sanofi-Aventis is the most exposed to emerging markets, and I think has the best position to benefit from the very fast growing countries in the emerging markets.
Cook: And so as well as Sanofi-Aventis, are there any others that perhaps might be there to compete for that same section of the market?
Conover: Yeah, other firms on there. I think they're to a lesser degree and are still kind of ramping up, but one of the fastest growing players in emerging markets is AstraZeneca. It is a company, like we mentioned before similar to the rest of the industry is facing a very challenging patent cliff, and one of the ways it's dealing with its patent cliff is spending more on getting further entrenched in the emerging markets. So, while it's not as entrenched as Sanofi-Aventis, it is growing much quicker. So, I think that's one firm that you could potentially see causing more competitive dynamics in the emerging markets.
Cook: And so stepping back from emerging markets in particular, we've seen a couple of big M&A deals recently, what's driving that.
Conover: Well, when we take a look at M&A, I think there’s a couple of things driving it. One, the patent cliff when you have all these sales dropping off, you have to find some way to replenish that and the pipelines of big pharmaceutical firms haven't been as productive as they have been in maybe the previous decade. So, you've got kind of a weak pipeline, a horrible patent cliff coming up. One way to mitigate that, one strategic alternative is to do a major acquisition. So, I think that's really fuelling the acquisitions that we've seen over the last couple of years, and I think it'll continue to fuel acquisitions over the next two to three years.
Cook: So for the sector as a whole, is it fair to say that it's kind of a sunny outlook or are there still those clouds there that are kind of a little bit too worrisome.
Conover: I would say that the outlook is still some challenging hurdles ahead. However, from a valuation perspective we think those challenge have been extrapolated way too far into the future and represent a lot of interesting buying opportunities. So, while even though the actual strategy and the competitive environment of these firms is potentially challenged in the near-term, I think the valuations of these firms offer a lot of compelling buy opportunities.
Cook: Okay. Well, that's very encouraging to hear. Thanks so much for joining me today.
Conover: Great, thanks for having me.
Cook: For Morningstar, I'm Holly Cook. Thanks for watching.
