Controlling the cost of prescription medications is an election issue on both sides of the Canada–U.S. border. But as with many things, America has an oversize influence on the $1.2 trillion global market for pharmaceuticals.
While the current U.S. government administration has loosened rules for coal and oil companies, it wants to rein-in the pharmaceutical industry, and the White House has made price control a priority.
In a rambling scrum with reporters last July, U.S. President Donald Trump suggested he had an executive order in the works to require pharmaceutical companies to offer federal programs among the lowest prices in the world, through a most-favoured nation clause.
"Why should other nations, like Canada ... but why should other nations pay much less than us? They've taken advantage of the system for a long time ... pharma."
A complex pricing problem seeks a simple solution
One thing Republicans and Democrats actually agree on is that drug prices have constantly risen above general inflation levels in the U.S., and are pinching voters... uh, patients, for out-of-pocket expenses.
Doing something about it is daunting in light of a lobbying war between drug makers, insurance companies, hospitals and pharmacy benefit managers.
Most drug formularies in the U.S. are managed by intermediaries and private insurers. The costs of many federal drug programs are not directly paid by the government itself. The pricing system lacks transparency, with manufacturers' "list" prices subject to negotiation, rebates and confidential price adjustments no one else sees–akin to the car industry.
Legislators try hard... but aren't getting anywhere fast
One bipartisan bill to reform drug pricing for seniors' and government programs, advanced by the Senate Financing Committee last July, has been all but dismissed by some lobbyists as a socialistic plot that would stop pharmaceutical companies from curing disease.
An even more ambitious plan introduced in Congress last month (September 2019) by House Speaker Nancy Pelosi targets, among other things, two key powers to control drug prices.
First, it would give the Secretary of Health & Human Services (HHS) authority to negotiate prices not just for Medicare, but also for the private market, over the 250 most-costly branded drugs that lack a generic or biosimilar competitor.
Second, it would control price increases on all prescriptions drugs covered by Medicare–not just the top 250. Any amount above inflation would be excised back to the Treasury as a rebate.
Pharma investors factor in the costs of uncertainty
The sentiment is that change is coming—if not exactly what, or when. Investors are now anticipating the impact on the industry—and the value of pharmaceutical stocks.
The most out-of-consensus view from our investment research is that the likelihood of Congress passing any kind of meaningful drug price control legislation is around 50/50 ahead of the 2020 election. And a majority of investors expect price controls are more likely to get real after the vote.
Either way, uncertainty has soured investors' appetite for the industry as a whole: U.S. pharmaceutical stocks have underperformed the broader S&P Index by almost 11% over the past twelve months.
While stock prices are down, margins still good
Pharmaceutical stocks are trading at a price-to-earnings ratio of about 13.6 times 2020 expected earnings; much cheaper compared to the 15.5 ratio a year ago.
We anticipate sales growth in the sector of around 4.8% in 2019 and 6.9% in 2020. Margins are expected to be strong, at approximately 38% in 2019 and 2020.
Even if the Congressional bill were to pass into law as-is, a look at a couple of names in our portfolios, Johnson & Johnson and Pfizer, suggests limited exposure. An analysis of drug-spending data suggests that about 10-to-15% of revenues for both companies are generated by drugs that might potentially be negotiated down in price.
No cause for drama in your portfolio
Whether the U.S. makes a move to lower drug prices before or after the 2020 election, we expect that regulatory uncertainty will continue to weigh on the value of pharma stocks until the issue is resolved in Congress.
We are underweight the pharmaceutical industry in our U.S. Equity Pool, and have assessed that our major holdings would have limited exposure to any effects from the proposed pricing bills. Showing resilience to regulatory pressures, Johnson & Johnson, even reported better-than-expected earnings for the third-quarter 2019, and raised its guidance on adjusted earnings per share.
As we continue to monitor developments, it's always against a wider backdrop of emerging innovation in the healthcare industry. By investing in market leaders and companies vying to meet future or unmet needs in healthcare, our portfolios are diversified to foresee disruptions and stick to a long-term, buy-and-hold philosophy.