Storm Clouds Brewing For Big Pharma

|
Includes: BTEC, CURE, FHLC, FTXH, FXH, HQH, IHE, IYH, JHMH, LNGR, MRK, PFE, PILL, PJP, PPH, RXD, RXL, RYH, THQ, VHT, XLV, XPH
by: Michael Chandler
Summary

For those of you investing in Big Pharma, you may want to keep a close eye on developments in Washington over the next two years.

The Democrats' proposal overlaps much of the blueprint Pres. Trump proposed last May.

In the United States prescription drugs are up to 100% more expensive than the rest of the world.

If the 2003 Medicare Part D legislation prohibiting price negotiation were lifted, the pharmaceutical industry would lose its pricing power. The windfall it enjoyed would quickly be reversed.

I would be cautious and keep an eye on these developments in Washington.

For those of you investing in Big Pharma, you may want to keep a close eye on developments in Washington over the next two years. The cost of pharmaceuticals may very well be the number one issue leading up to the 2020 election, and this year it may very well be different.

This year, the Democrats have control of the House of Representatives. Back in 2015, Congressman Cummings of the Seventh Congressional District of Maryland and Sen. Bernie Sanders introduced the Prescription Drug Affordability Act. It was basically a blueprint put forward as a democratic initiative. Of course, it went nowhere with the Republicans controlling the house. Had it passed, this bill would have eliminated the windfall for the pharmaceutical industry by lifting the prohibition of price negotiation in the 2003 Medicare Part D Law.

In many ways, this Act overlaps much of the blueprint Pres. Trump proposed last May. In fact, it’s interesting to note Congressman Cummings met with Pres. Trump on numerous occasions prior to the President's blueprint being released. It appears some form of the Prescription Drug Affordability Act could very well pass as we lead up to the 2020 election.

Wells Fargo analyst David Maris has been talking about drug prices for years, and on Wednesday, he wrote that it’s not a safe assumption that the results are a positive for pharma, despite the Republicans’ strong hold on the Senate.

"We think 2019-2020 could be a very healthcare-focused Congress with intensifying uncertainty during the next presidential election cycle,” he wrote. “With Democrats running key committees - including Elijah Cummings, who has been focused on healthcare and who will now head the Oversight Committee - we believe that drug prices and healthcare will stay a hot topic.”

In the first two years of Trump's presidency, there’s been considerable talk and, more recently, some action on drug prices. The FDA has approved a record number of generic drugs in an effort to reduce prices, and HHS is pushing for prices in TV advertising. The administration is also looking to reduce certain prices in the U.S. to international levels, among other efforts.

Rep. Mark Meadows, R-N.C., said during the event that he had a message from Trump to convey to the committee. “He wanted me to make sure that you knew that on this particular subject, not only is he serious, he's serious about working in a bipartisan way to lower prescription drug prices, and when I spoke to him last night, he wanted to make sure I conveyed that to you,” Meadows said, as quoted by CNBC and several other media outlets.

"We are willing, able and ready to work with them to get them done,” Cummings responded.

The escalating cost of prescription drugs is nothing new. We have lived with it for many years, or at least since 2003’s passage of the Medicare Part D Law prohibiting price negotiations.

According to a government report, while name brand drugs comprise only 10% of all dispensed prescriptions in the United States, they account for 72% of drug spending. Between 2008 and 2015, prices of most commonly used name brand drugs increased 164%, far in excess of the consumer price index of 12%.

Furthermore, in the United States, prescription drugs are up to 100% more expensive than the rest of the world. Here’s what The Hill had to say back in January 2018: Americans pay prices for prescription drugs that are two to six times the rest of the world, despite having personal incomes that are on par with many developed countries.

Basically, this means the United States is paying for much of the research & development of new drugs, creating a huge benefit for the rest of the world. This is primarily due to the fact that foreign governments, for the most part, negotiate their prices directly with the pharmaceuticals. Both the Democratic initiative and Pres. Trump’s blueprint address this issue, albeit in somewhat of a different manner.

Another initiative is to streamline FDA approval of new drugs and to emphasize its approval of generic brands and biosimilar product development. According to the FDA Commissioner, Scott Gottlieb, M.D., the FDA approved more than 1000 generic drugs in 2017 and expects to exceed that number in 2018.

Other initiatives include transparency in pricing for both name brand and generics by mandating full disclosure as well as passing rebates down to the consumer.

The pharmaceutical industry is certainly not taking these proposals lightly. In a federal filing, according to CNN, last year Big Pharma spent $27.5 million on lobbying efforts to protect their interest. Previously, they spent $25 million as the Affordable Care Act was being debated. According to Open Secrets, a nonpartisan research group, healthcare spent $556,276,018 in lobbying efforts 2018.

The pharmaceutical industries response to these initiatives are that research and development of new cutting-edge drugs would be significantly curtailed, citing this study:

The Deloitte Center for Health Solutions in the U.S. and the United Kingdom concluded in its latest analysis last year that the pharmaceutical industry “continues to face regulatory and reimbursement hurdles weighing on the research and development (R&D) returns of pharmaceutical firms.”

Based on a review of the estimated returns of 12 leading biopharma companies and comparing their performance with four mid-to-large-cap companies, the study found that annual projected PhRMA returns continued to decline to 3.7 percent, while the long-term costs related to bringing a product to market remained at roughly $1.5 billion.

It’s very clear to me the chances are very good we will see legislation passed targeting the pricing of pharmaceuticals. It may be indirect, by a concerted effort of FDA to approve generic drugs and biosimilar meds, or forcing the cost sharing of R&D throughout the world. In fact, it appears some of these techniques are already being put in place.

Whether we see direct negotiation of prices with Medicare or Medicaid is another subject. It appears there are differing opinions regarding this in Washington. Nonetheless, I expect it to be on the table.

Any legislation targeting the high cost of medicine today will certainly have a negative impact on the pharmaceutical industries margins. Furthermore, as the industry has warned, it could certainly have negative repercussions on R&D.

Close to 30% of all pharmaceutical retail sales come through Medicare. If the prohibition against negotiation of price brought forth in the 2003 Medicare Part D legislation were lifted, the pharmaceutical industry would lose its pricing power, and the windfall they enjoyed from that legislation would quickly be reversed.

Historically, pharmaceuticals have been considered defensive by nature. Big Pharma has enjoyed wonderful cash flows, as reflected by their attractive dividends. Merck (MRK) and Pfizer (PFE) are two names that come to mind with good pipelines of new products while carrying around a 3% dividend.

As much as I think Merck’s outlook is positive, particularly with its new mega drug for cancer, Keytruda, the company, along with the rest of Big Pharma, might not be as defensive as we had once thought. The mere thought of losing pricing power could be devastating to even the best of the best.

Many money managers are recommending a more defensive posture for 2019. Pharmaceuticals historically would fit that bill to a T. As an investor in pharmaceuticals, I would be cautious and keep one eye on these developments in Washington.

Clearly, storm clouds are brewing for Big Pharma!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: You should consider your personal financial situation, investment objectives, risk tolerance and needs prior to making investment decisions. Not all strategies discussed may be suitable for all investors.
Investment advisory services offered through World Equity Group, Inc., member FINRA and SIPC, a Registered Investment Adviser.

Dogwood Capital Management is not owned or controlled by World Equity Group, Inc.