News & Insight • Podcasts
24 May 2021 | Paul Dixey
What is wrong with Big Pharma? - Part 1
In Episode 7 Part 1, the two Simons and Tim look beyond Covid-19 and talk to Paul about the issues facing pharmaceutical companies, why GlaxoSmithKline is coming under pressure and one of the largest biopharma companies you may have never heard of…
Read the transcript below:
Paul Dixey 00:43
Good morning, and welcome to the latest episode of The Art of investment. I'm Paul Dixey, your host and today we have a full house on the podcast. I'm joined by regulars, Tim Gregory - manager of the Vermeer Global Fund, Simon King - CIO of Vermeer Partners and making his debut today, Simon Barrel. Simon is an Investment Manager with Vermeer Partners but he also researches the pharmaceutical sector for us, which is going to be helpful today during our discussion. We'll be focusing on the pharmaceutical sector, we'll be looking at why there's been an underwhelming performance of Big Pharma, particularly prior to the pandemic, the reasons why the shares haven't performed particularly well. And we'll also be drawing on some case studies concentrating on a few companies, notably GlaxoSmithKline, Bristol Myers Squibb and Novo Nordisk. So Tim, let me come to you first, if you don't mind, we'd like to understand why Big Pharma has struggled recently and why there historically has been the sort of overhang on share prices? I think we've seen a lot in terms of drug pricing issues, particularly in the US, but I wonder whether you could give us your thoughts on that.
Tim Gregory 02:01
I think it's been a very long time now that the market has worried about a negative pricing environment in the US, that actually to a large extent, hasn't really come to fruition, albeit that actually, while some drugs are enormously expensive, some drugs are actually at the lower end of the pricing scale. In the US these days, and it's the US that has been front and centre because in other parts of the world, drug prices are so much lower, it's been a permanent overhang for the sector, for a very long time now. Every time we seem to go into a political cycle - just going into election there is always a lot of noise about what an incoming President might do in terms of regulating drug prices - I think it's perceived as a vote winner. President Trump, in his time, made a lot of noise about the issue, but was unsuccessful in actually changing anything. And similarly now, we're seeing similar moves by the President Biden administration. And we're moving into that phase now, where it may become clearer and we may get a new pricing regime. But actually, there's also the possibility that, once again, it's pushed into the tall grass. And actually, as I've said on a number of occasions previously, it would be better for the companies from a profitability perspective. But it would be better for investors to have a clear line of sight to a new sustainable pricing regime. And that might lead to short term earnings downgrades. I think stocks could rewrite in that environment because of the clearing event that that would create. So I think that's been the key, what is ironic is that, as you said, these stocks were struggling going into the pandemic, because they weren't cyclical enough. And they had a brief moment, where they did very well when everyone was moving to very defensive parts of the market. And ever since then of course, they've been struggling because they're not cyclical enough. They're not reopening trades, they're not great structural growth trades - because we know that the market has been dominated by either ever higher valuations (for high growth technology related names) or cyclical reopening trades, post the announcement that a vaccine have been successful. So they have never been in the right place, at the same time as having this very significant overhang from pricing issues. And actually it's my view that a patient investor, who can see past whatever outcome we see on the pricing issues, is that it's one of the last remaining cheap sectors with some very fine companies who spent absolute fortunes on R&D, whether it be Merck, Bristol Myers that Simon's going talk to about later on, or Novo Nordisk in the diabetes and obesity space that I'm going to try to make some reference to later. But, these are very, very cheap relative to the high prices being paid for equities, in general, and actually are also supported by very good yields in many cases, and I think that makes them attractive in a pretty difficult market.
Paul Dixey 05:24
I guess one of the companies that has been certainly gaining a lot of attention recently is GlaxoSmithKline, which I historically would have been a name in most investors portfolios. But as we've seen, Elliott Management, the activists have taken a multi-billion pound stake in the business putting the CEO Emma Warmsley, under a lot of pressure. We now have a clip from CNBC, that's going to highlight some of the issues circulating on GlaxoSmithKline… So Simon King, we've just heard about a few of the issues with Glaxo. Obviously they've been behind the curve relative to AstraZeneca and Pfizer in terms of the COVID vaccine race. What do you think the future is for Glaxo?
Simon King 08:26
The big, big issue with that at the moment is it is being hit on two different bases. One, all the problems that are generally around with Big Pharma, then it's also compounded those problems with individual issues of its own. It ticks all the boxes in terms of the general negative attitude towards Big Pharma. It's neither seen as growth nor value, and then has specific price overhangs. Then longer term the real bears of the sector would say, these companies are too big, they're too complex, their M&A has been poor, they've become less innovative over time and sort of jack of all trades and that's led to a plethora of smaller, more agile companies emerging either at the innovation end or even in manufacture and delivery. They're just not as good as they used to be. It’s probably unfair generally, in that there are still some very good companies within the sector. They are very much out of favour. GlaxoSmithKline has got all of that to contend with and has got itself in a bit of a mess over the last two or three years. With all pharma companies, these are very long cycle companies, initiatives you take now often take up to 10 years to come through. It's undoubtedly the case that the current management team is dealing with many of the poor decisions taken by their predecessors. But unfortunately, the perception in the market now is that they have been very slow to change. There was a great deal of optimism when Emma Walmsley came into the company, she wasn't from a pharmaceutical background, she has more of a consumer goods background, and it was assumed she would inject some dynamism - that may have been overly optimistic. Investors have grown bored and Elliott, the well-known activist shareholder has taken a stake and has actually said very little about what he wants the company to do, or what they want the company to do, or indeed, what their strategy should be. We remain in waiting mode to see what happens there. The reasons it's got itself into this position, apart from the corporate side, has been a poor delivery on pipeline and indeed, that highlights another issue with the sector. A lot of these drug decisions are binary. They either work or they don't, there's nothing in between. So, if you happen to get an unlucky run, as some would suggest, Glaxo are at the moment, they've compounded that further by failing to deliver a COVID-19 vaccine. Obviously, given the vaccine is one of their supposed areas of strength that's been taken particularly badly in the market. Again the bulls will say, they've just been unlucky and everything will revert to mean. I take the famous golfing adage from Lee Trevino, which is “the harder I practice, the luckier I get seem to get”. This is what they do, so they should be delivering on this. It's a trend, they'd have to stop very, very quickly if they want the shares to recover. That basically leaves us in a bit of a quandary, as most people will be aware, the company has announced over 18 months ago that it was going to demerge. It has split itself into two - a pure pharmaceuticals business and a consumer business. That has taken forever to be achieved and still won't happen until the middle of 2022. The market is assuming that there will be a dividend cut as a result of that, and as yet, there's been no guidance on that. So, the jury is very much out. The Bears are winning at the moment - from our perspective. We try to look at things internationally at Vermeer Partners. We look right across the pharma sector and we just believe there are better opportunities elsewhere in the globe.
Paul Dixey 12:54
That's interesting and you talk about opportunities on a global perspective. If we jump across the pond, there's a company called Bristol Myers Squibb, which perhaps isn't well known to UK investors, but it is a huge global biopharma company with an extraordinarily long history. Simon Barrell, I know that this is one that you like looking at. With a huge deal a couple of years ago, but I wonder whether you can talk us through why you like Bristol Myers Squibb, and give us your thesis on that one.
Simon Barrell 13:27
I think this is a prime example of one of the pharma stocks that Tim highlighted earlier. I think it looks really cheap, especially after the market reaction to the Q1 numbers. But for me, it's the excellent cash flow and sound balance sheet, a company paying sustainable and growing dividend. It's actively paying down debt because there is a lot of debt, $48bn, after the acquisition of Celgene. There is a share buyback program as well in place, they're buying back $2bn worth of shares, and they're currently up to $6.4bn bought back so far. But the big thing for me is the wider product range covering: cancer, HIV, cardiovascular, hepatitis, rheumatoid arthritis, psychiatrics. It's a big, broad spectrum there. Bristol Myers also controls three of the six biggest selling drugs in the world at the moment. But the other thing is the deep and broad pipeline they have they've got currently- there are over 50 compounds in development, covering 40 disease classes. In Calgene, they have 22 late-stage compounds in the pipeline. Statistically you would expect about 58% of these to become commercial products and these cover areas such as multiple sclerosis, cancer, using the exciting Carty technologies as well.
Tim Gregory 14:56
It was noteworthy to me - I saw recently that Berkshire Hathaway’s Warren Buffett either increased his stake or has taken a stake in Bristol Myers. Obviously he's seeing value in that as well. Why do you think the market is being so negative given that valuation and given what you're saying about the pipeline?
Simon Barrell 15:14
I think first of all, there's a lot of scepticism about the Celgene deal because they had been a bit lacklustre, pipeline wise. There's also of course the pricing pressure, as Tim mentioned earlier, but in this case, I think it's a bit overdone because one has to bear in mind that Bristol Myers treat very serious diseases and also diseases that are orphan status. So it would be very hard for them to attack Bristol Myers on pricing.
Paul Dixey 15:48
That's really interesting. Simon, I think you deserve a lot of credit as just to be able to pronounce some of those diseases and drug names. So very, very interesting. Tim, let me come to you on Novo Nordisk. Clearly diabetes is a huge issue for the world over 415mn people living with the disease globally, that's expected to rise to over 640mn by 2040. Clearly Novo Nordisk are well placed to deal with this issue. But what else are you seeing in terms of Novo Nordisk as a good investment at the moment?
Tim Gregory 16:25
It's really interesting because, contrary to the commentary that we've been talking about how cheap Glaxo are, how cheap Bristol Myers and how cheap most of the stocks in the sector are, it has a franchise in diabetes, and more recently, it’s grown exponentially in obesity. Novo has been one of the stocks that has actually been able to escape the broader devaluation that the sector has suffered naturally. Relatively speaking, it's quite an expensive share, albeit not expensive in the context of the overall market. Novo has done so well, because it has been a dominant player in the insulin market in this horrendous period we had where diabetes has grown so fast and 80% of Novo sales are in the diabetes area. At this point, only 5% cover obesity. You throw out some horrendously large numbers there for the number of potential patients there are in the diabetes market, but actually, the numbers for obesity are very similar. I did a conference call with a company quite recently, and they said that globally, they thought 650mn people are clinically obese. At this point, only 65 million of those are actually seeing the doctor. What the market is hoping for and which you get a readout on a critical product in early June, so it's a very front and centre, is that a product will be approved that is going to show considerable weight loss for patients via an injection to be taken monthly in a protocol semaglutide. That is absolutely critical to what happens to the stock next. But at this point, obesity sales are only 5% of the total for Novo Nordisk and on the basis of those the numbers that you're throwing out there, which, supported by what the company says the opportunity for them in that market is really very large. That's why that stock has been able to afford a substantial premium and also is working very hard to try and grow a fourth leg to its business. It is one of the companies, like so many, that would like to be a forerunner in developing a product for Alzheimer’s which has been such a terrible illness for which there has been no cure. Hopefully, from a perspective of the community and the world, they find something in that area or somebody does, because that is a dreadful disease that at this point, no one's been able to solve. They've invested extremely heavily to be front and centre in these areas. It has helped the shares perform better than the rest of the market and I think that's fully deserved. If they're successful in obesity and in other areas, they'll continue to enjoy that premium to the market.
Paul Dixey 19:48
I think having just heard all of your commentary on those three stocks it is clear there are some losers there but also the odd winner. We should wrap it up now, but I think the key points to take away from the chat there is that we need some clarity on the drug pricing issue to remove this overhang on the stocks generally. They appear to be relatively cheap across the board, but that overhang needs to be lifted for those stocks to re-rate and be beneficial to investors. So, just to thank all three of you for your expert views, we had better call stumps for the day.
Key Points
• Read the transcript below:
Paul Dixey 00:43 Good morning, and welcome to the latest episode of The Art of investment. I'm Paul Dixey, your host and today we have a full house on the podcast. I'm joined by regulars, Tim Gregory - manager of the Vermeer Global Fund, Simon King - CIO of Vermeer Partners and making his debut today, Simon Barrel. Simon is an Investment Manager with Vermeer Partners but he also researches the pharmaceutical sector for us, which is going to be helpful today during our discussion. We'll be focusing on the pharmaceutical sector, we'll be looking at why there's been an underwhelming performance of Big Pharma, particularly prior to the pandemic, the reasons why the shares haven't performed particularly well. And we'll also be drawing on some case studies concentrating on a few companies, notably GlaxoSmithKline, Bristol Myers Squibb and Novo Nordisk. So Tim, let me come to you first, if you don't mind, we'd like to understand why Big Pharma has struggled recently and why there historically has been the sort of overhang on share prices? I think we've seen a lot in terms of drug pricing issues, particularly in the US, but I wonder whether you could give us your thoughts on that. Tim Gregory 02:01 I think it's been a very long time now that the market has worried about a negative pricing environment in the US, that actually to a large extent, hasn't really come to fruition, albeit that actually, while some drugs are enormously expensive, some drugs are actually at the lower end of the pricing scale. In the US these days, and it's the US that has been front and centre because in other parts of the world, drug prices are so much lower, it's been a permanent overhang for the sector, for a very long time now. Every time we seem to go into a political cycle - just going into election there is always a lot of noise about what an incoming President might do in terms of regulating drug prices - I think it's perceived as a vote winner. President Trump, in his time, made a lot of noise about the issue, but was unsuccessful in actually changing anything. And similarly now, we're seeing similar moves by the President Biden administration. And we're moving into that phase now, where it may become clearer and we may get a new pricing regime. But actually, there's also the possibility that, once again, it's pushed into the tall grass. And actually, as I've said on a number of occasions previously, it would be better for the companies from a profitability perspective. But it would be better for investors to have a clear line of sight to a new sustainable pricing regime. And that might lead to short term earnings downgrades. I think stocks could rewrite in that environment because of the clearing event that that would create. So I think that's been the key, what is ironic is that, as you said, these stocks were struggling going into the pandemic, because they weren't cyclical enough. And they had a brief moment, where they did very well when everyone was moving to very defensive parts of the market. And ever since then of course, they've been struggling because they're not cyclical enough. They're not reopening trades, they're not great structural growth trades - because we know that the market has been dominated by either ever higher valuations (for high growth technology related names) or cyclical reopening trades, post the announcement that a vaccine have been successful. So they have never been in the right place, at the same time as having this very significant overhang from pricing issues. And actually it's my view that a patient investor, who can see past whatever outcome we see on the pricing issues, is that it's one of the last remaining cheap sectors with some very fine companies who spent absolute fortunes on R&D, whether it be Merck, Bristol Myers that Simon's going talk to about later on, or Novo Nordisk in the diabetes and obesity space that I'm going to try to make some reference to later. But, these are very, very cheap relative to the high prices being paid for equities, in general, and actually are also supported by very good yields in many cases, and I think that makes them attractive in a pretty difficult market. Paul Dixey 05:24 I guess one of the companies that has been certainly gaining a lot of attention recently is GlaxoSmithKline, which I historically would have been a name in most investors portfolios. But as we've seen, Elliott Management, the activists have taken a multi-billion pound stake in the business putting the CEO Emma Warmsley, under a lot of pressure. We now have a clip from CNBC, that's going to highlight some of the issues circulating on GlaxoSmithKline… So Simon King, we've just heard about a few of the issues with Glaxo. Obviously they've been behind the curve relative to AstraZeneca and Pfizer in terms of the COVID vaccine race. What do you think the future is for Glaxo? Simon King 08:26 The big, big issue with that at the moment is it is being hit on two different bases. One, all the problems that are generally around with Big Pharma, then it's also compounded those problems with individual issues of its own. It ticks all the boxes in terms of the general negative attitude towards Big Pharma. It's neither seen as growth nor value, and then has specific price overhangs. Then longer term the real bears of the sector would say, these companies are too big, they're too complex, their M&A has been poor, they've become less innovative over time and sort of jack of all trades and that's led to a plethora of smaller, more agile companies emerging either at the innovation end or even in manufacture and delivery. They're just not as good as they used to be. It’s probably unfair generally, in that there are still some very good companies within the sector. They are very much out of favour. GlaxoSmithKline has got all of that to contend with and has got itself in a bit of a mess over the last two or three years. With all pharma companies, these are very long cycle companies, initiatives you take now often take up to 10 years to come through. It's undoubtedly the case that the current management team is dealing with many of the poor decisions taken by their predecessors. But unfortunately, the perception in the market now is that they have been very slow to change. There was a great deal of optimism when Emma Walmsley came into the company, she wasn't from a pharmaceutical background, she has more of a consumer goods background, and it was assumed she would inject some dynamism - that may have been overly optimistic. Investors have grown bored and Elliott, the well-known activist shareholder has taken a stake and has actually said very little about what he wants the company to do, or what they want the company to do, or indeed, what their strategy should be. We remain in waiting mode to see what happens there. The reasons it's got itself into this position, apart from the corporate side, has been a poor delivery on pipeline and indeed, that highlights another issue with the sector. A lot of these drug decisions are binary. They either work or they don't, there's nothing in between. So, if you happen to get an unlucky run, as some would suggest, Glaxo are at the moment, they've compounded that further by failing to deliver a COVID-19 vaccine. Obviously, given the vaccine is one of their supposed areas of strength that's been taken particularly badly in the market. Again the bulls will say, they've just been unlucky and everything will revert to mean. I take the famous golfing adage from Lee Trevino, which is “the harder I practice, the luckier I get seem to get”. This is what they do, so they should be delivering on this. It's a trend, they'd have to stop very, very quickly if they want the shares to recover. That basically leaves us in a bit of a quandary, as most people will be aware, the company has announced over 18 months ago that it was going to demerge. It has split itself into two - a pure pharmaceuticals business and a consumer business. That has taken forever to be achieved and still won't happen until the middle of 2022. The market is assuming that there will be a dividend cut as a result of that, and as yet, there's been no guidance on that. So, the jury is very much out. The Bears are winning at the moment - from our perspective. We try to look at things internationally at Vermeer Partners. We look right across the pharma sector and we just believe there are better opportunities elsewhere in the globe. Paul Dixey 12:54 That's interesting and you talk about opportunities on a global perspective. If we jump across the pond, there's a company called Bristol Myers Squibb, which perhaps isn't well known to UK investors, but it is a huge global biopharma company with an extraordinarily long history. Simon Barrell, I know that this is one that you like looking at. With a huge deal a couple of years ago, but I wonder whether you can talk us through why you like Bristol Myers Squibb, and give us your thesis on that one. Simon Barrell 13:27 I think this is a prime example of one of the pharma stocks that Tim highlighted earlier. I think it looks really cheap, especially after the market reaction to the Q1 numbers. But for me, it's the excellent cash flow and sound balance sheet, a company paying sustainable and growing dividend. It's actively paying down debt because there is a lot of debt, $48bn, after the acquisition of Celgene. There is a share buyback program as well in place, they're buying back $2bn worth of shares, and they're currently up to $6.4bn bought back so far. But the big thing for me is the wider product range covering: cancer, HIV, cardiovascular, hepatitis, rheumatoid arthritis, psychiatrics. It's a big, broad spectrum there. Bristol Myers also controls three of the six biggest selling drugs in the world at the moment. But the other thing is the deep and broad pipeline they have they've got currently- there are over 50 compounds in development, covering 40 disease classes. In Calgene, they have 22 late-stage compounds in the pipeline. Statistically you would expect about 58% of these to become commercial products and these cover areas such as multiple sclerosis, cancer, using the exciting Carty technologies as well. Tim Gregory 14:56 It was noteworthy to me - I saw recently that Berkshire Hathaway’s Warren Buffett either increased his stake or has taken a stake in Bristol Myers. Obviously he's seeing value in that as well. Why do you think the market is being so negative given that valuation and given what you're saying about the pipeline? Simon Barrell 15:14 I think first of all, there's a lot of scepticism about the Celgene deal because they had been a bit lacklustre, pipeline wise. There's also of course the pricing pressure, as Tim mentioned earlier, but in this case, I think it's a bit overdone because one has to bear in mind that Bristol Myers treat very serious diseases and also diseases that are orphan status. So it would be very hard for them to attack Bristol Myers on pricing. Paul Dixey 15:48 That's really interesting. Simon, I think you deserve a lot of credit as just to be able to pronounce some of those diseases and drug names. So very, very interesting. Tim, let me come to you on Novo Nordisk. Clearly diabetes is a huge issue for the world over 415mn people living with the disease globally, that's expected to rise to over 640mn by 2040. Clearly Novo Nordisk are well placed to deal with this issue. But what else are you seeing in terms of Novo Nordisk as a good investment at the moment? Tim Gregory 16:25 It's really interesting because, contrary to the commentary that we've been talking about how cheap Glaxo are, how cheap Bristol Myers and how cheap most of the stocks in the sector are, it has a franchise in diabetes, and more recently, it’s grown exponentially in obesity. Novo has been one of the stocks that has actually been able to escape the broader devaluation that the sector has suffered naturally. Relatively speaking, it's quite an expensive share, albeit not expensive in the context of the overall market. Novo has done so well, because it has been a dominant player in the insulin market in this horrendous period we had where diabetes has grown so fast and 80% of Novo sales are in the diabetes area. At this point, only 5% cover obesity. You throw out some horrendously large numbers there for the number of potential patients there are in the diabetes market, but actually, the numbers for obesity are very similar. I did a conference call with a company quite recently, and they said that globally, they thought 650mn people are clinically obese. At this point, only 65 million of those are actually seeing the doctor. What the market is hoping for and which you get a readout on a critical product in early June, so it's a very front and centre, is that a product will be approved that is going to show considerable weight loss for patients via an injection to be taken monthly in a protocol semaglutide. That is absolutely critical to what happens to the stock next. But at this point, obesity sales are only 5% of the total for Novo Nordisk and on the basis of those the numbers that you're throwing out there, which, supported by what the company says the opportunity for them in that market is really very large. That's why that stock has been able to afford a substantial premium and also is working very hard to try and grow a fourth leg to its business. It is one of the companies, like so many, that would like to be a forerunner in developing a product for Alzheimer’s which has been such a terrible illness for which there has been no cure. Hopefully, from a perspective of the community and the world, they find something in that area or somebody does, because that is a dreadful disease that at this point, no one's been able to solve. They've invested extremely heavily to be front and centre in these areas. It has helped the shares perform better than the rest of the market and I think that's fully deserved. If they're successful in obesity and in other areas, they'll continue to enjoy that premium to the market. Paul Dixey 19:48 I think having just heard all of your commentary on those three stocks it is clear there are some losers there but also the odd winner. We should wrap it up now, but I think the key points to take away from the chat there is that we need some clarity on the drug pricing issue to remove this overhang on the stocks generally. They appear to be relatively cheap across the board, but that overhang needs to be lifted for those stocks to re-rate and be beneficial to investors. So, just to thank all three of you for your expert views, we had better call stumps for the day.