Sophie Meatyard: Is there a cure for ‘misbehaving’ pharma?

Sector trailing other traditional late cycle winners despite strong earnings growth

The threat of drug pricing reforms is dampening the US healthcare sector’s performance this year. The sector is considered a defensive investment and typically performs well towards the end of an economic cycle. Other sectors with similar characteristics are having a strong 2019 – consumer staples and utilities have returned upwards of 20%, but the healthcare sector is lagging by around 10%.

There are two reasons the sector is considered a defensive investment.  The first is that the need for medical services remains the same regardless of the economic cycle and the second, many of these companies have strong balance sheets.

This profile should ensure healthcare is well positioned in the current economic environment. According to the Bank of America Merrill Lynch fund manager survey in July, investors remain overweight to the sector, particularly within pharmaceuticals. Given this positioning and outlook, is the potential crackdown on pricing really a concern?

Source: FE

As healthcare is something that affects everyone, there is a political campaign strategy to take on the large pharmaceutical companies that are “misbehaving”, overcharging consumers for the drugs required for daily lives.

The more recent news flow surrounding pricing has led Congress to propose legislation at the end of July to try to redress the balance of power between the consumer and the healthcare sector. The main points of the legislation include penalising companies who raise prices for Medicare patients beyond inflation and introducing a cap on patients’ contribution to Medicare. Pharmaceutical shares have managed to hold their ground following the announcement, as the bill may not yet become law.

The steps to implement the bill require the legislation to pass through the US House of Representatives, the US Senate and the President. Considering the US election is next year, the likelihood that all three will agree to the legislation seems slim as it could be used in the campaign to undermine an opponent.

While many agree that the staggering price increases by a number of pharmaceutical companies are unethical, it’s difficult to see a successful conclusion to the latest ‘war’ on drug prices given the political climate leading up to an election.

On the run up to elections, extreme policies are often touted but once analysed in more depth, are often watered down in order to pass through the legislature. Both the Republicans and the Democrats are competing to be the party that promises the most, in order to win voters loyalty ahead of the US 2020 election.

However, historically the likelihood of seeing these promises come to fruition is negligible. Trump has promised to unveil his “elaborate” strategy to overhaul the nation’s healthcare system in September, he made similar promises during his 2016 campaign and is keen to have results to show for his re-election campaign.

Despite associated cynicism, politicians can still have positive impact regardless of legislation.  Trump’s tweets following Pfizer’s announcement last year increasing the prices of over a hundred of their products in the pharmaceutical industry’s traditional semi-annual hiking cycle, initially stopped the company in its tracks. Despite this positive outcome, Pfizer commented they would defer these increases until the end of the year, or until there was more clarity surrounding Trump’s plan to curb the increases. Regrettably this suggests the President can only provide a delay rather than a cure.

Another reason the under-pressure sector may be in temporarily pain, is the significant amount of money drug makers and health insurers have been spending lobbying congress. Drug makers spent a record amount lobbying Congress in the first half of 2019. The questionable practice of lobbying can lead companies to spend significant amounts of money hiring a lobbyist, to persuade politicians to support their interests. These lobbyists are able to influence politicians to reconsider their political outlook and actions. This can relate to a specific area of interest in relation to campaign donations politicians receive from, say, healthcare companies. This is just one of the lobbying methods used, with some methods of political influence being more ethical than others.

Considering the above, it seems the sector may be being overly punished considering healthcare companies are reporting good earnings growth with an increase of 9.8% in earnings per share for the first quarter from a year earlier, according to S&P Global Market Intelligence, but the political risk is likely to weigh on the sector in the near-term.

Sophie Meatyard is a fund analyst at FE Invest

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