Tuesday, June 23, 2009

Big Pharma – First Cracks Appearing?

Larry and I have been blogging for a while about the health (no pun intended) of Big Pharma. Earlier, we had even drawn comparisons to Big Auto. We’d left the theme for a while – there’s never a shortage of stories about this industry. But, a couple of weeks ago, I came across an interesting article in Barron’s and I felt that I was no longer a lonely voice crying in the desert. There may actually be fellow travelers!

In the June 1, 2009 issue of Barron’s, Vito J. Racanelli in his column, The Trader, questioned the supposedly solid financial results of the pharmaceutical industry. He cited analytical work done at First Global by Kavita Thomas which reported that the superior return on equity (ROE) recently at large pharmaceutical companies was not a result of improved operating results but of also of charges to equity and stock buybacks. The types of charges noted arose from foreign exchange losses and pensions. Vito cited examples of Pfizer (PFE), Eli Lilly (ELI), Johnson & Johnson (JNJ) and Merck (MRK) where these activities took place.

Vito cites Kavita’s work as a potential leading indicator for the health of the pharmaceutical industry. He’s right. While I’ve been blogging about product pipelines and government intervention, Kavita has supplied the financial analysis that can be used to see where the industry is going. Interestingly, Vito comments on pharmaceuticals’ debt levels implying that they are not excessive although debt ratios are rising, again, because of falling equity numbers.

Both Thomas and Racanelli ask how long will the pharmaceuticals use creative financing and expense reductions to support their earnings. As we’ve seen in other industries as of late, it won’t last.

So, what next? I expect that we’ll probably see more creative accounting and attempts to reduce costs. But, it’s a zero sum game. Many of the pharmaceutical companies are sitting on large cash reserves and probably have access to other sources of funding. There won’t be a dramatic deterioration overnight in the financial situation of Big Pharma overnight. Possibly, some of the vendors supplying outsourcing and similar services may have a temporary surge until the money lasts and all cost cutting avenues have been exhausted.

One final word, watch those cash reserves at Big Pharma. Ford (F) is still alive, barely, but alive, because it had the foresight to arrange for lines of credit before they needed them. General Motors (GM) and Chrysler didn’t and had to go cap in hand to Washington looking for money. If the Obama administration succeeds in reducing drug costs in this country then Big Pharma may be having to follow the same path. Hopefully, they’ll leave their corporate jets at home.

As always, we welcome your feedback. Please contact us at larryrothmansblog@gmail.com. We look forward to hearing from you.

Contributed by Guy de Lastin

1 comment:

David Avitabile said...

Memo to Big Pharma: hundreds of billions of shareholder dollars spent, 80,000 jobs gone in the past few years, patent cliffs approaching fast, and nonexistent pipelines. Perhaps the answer to your problems may not lie in buying yet another company. Just a thought.