Healthcare Reform’s Illusionary Winners: Merck and Pfizer

Published by clickbroker.blogspot.com.

Pfizer (PFE) has repeatedly told us during the “great recession” that pharma cannot sell drugs to patients that don’t go to their doctors. This is especially true of the lifestyle drugs such as Pfizer’s Lipitor and Merck’s (MRK) Vytorin that require regular follow up. Whether you believe cholesterol is a real disease or not, you can understand that taking these drugs does not constitute a medical emergency.

Analysts have generally considered big pharma to be a winner in the new era of healthcare. With more insured and correspondingly more doctor visits, the logic goes more “optional” drugs will be sold. Given that the manufacturing cost of most lifestyle drugs, the bread and butter of big pharma, is extremely low compared to R&D and marketing expenses; increased volume could easily protect operating margins from lower prices.

However, this logic faces some challenges. Insurance costs for both employees and individuals will continue to rise exponentially until 2014, so the number of insured could actual fall in the short term. The value of many blockbuster lifestyle drugs, including blood thinner Plavix (SNY, BMY), are being questioned. Not to mention generic competition for many chemical based drugs.

The bulls point to extended patent protection for biological based drugs in the healthcare reform legislation signed by President Obama today, but biologicals have presented challenges for big pharma. Beyond development difficulties, there lies the uncertainty of the great squeeze coming once the government starts doling out subsidies in 2014.

I believe that once the budget deficits really start ballooning, both political parties will kneel at the altar of cost benefit. Suddenly it won’t matter if grandma dies a month earlier.

Buy big pharma based on the assumption that they will become utilities, just like the private health insurers. Look for low capital returns and high dividends. The market will bifurcate: low margin utility drugs and high-value truly innovative drugs. No longer will marketing make up for false innovation.

Disclosure: Author is long PFE.

Sphere: Related Content