Coronavirus and the Pharmaceuticals Sector: Observations and Outlook

A deep dive into Big Pharma's Q1 results

In response to the coronavirus pandemic, the equity markets have taken a significant jolt. Against the backdrop of an S&P 500 which is down 10% in 2020, pharmaceutical stocks have fallen about 5.27% YTD. As the pandemic played out, the public focus has shifted to companies in this sector, as has the urgent need for effective diagnostic tests, preventatives, therapeutics and, ultimately, a vaccine been realized. Almost every pharmaceutical firm is working to innovate to deliver within one of these channels. Two sectors have been responsible for the broad recovery of the S&P 500: healthcare and technology. Indeed, as of 11 May, the NASDAQ secured a sixth consecutive day of gains, its best winning streak all year. Such results have countered the extensive losses in financials, airlines, retail and energy. Notable examples include Amazon (NASDAQ: AMZN), which is up 26.46% YTD.

However, the debate over the sustainability of holding tech stocks, which are already more volatile than those in the defensive healthcare sector and trade at higher valuations is especially relevant going into a potential recession. In these environments, investors may be less inclined to hold these sectors when prioritizing value and stability over long-term growth. Instead, focusing on specific ‘coronavirus-resistant’ tech stocks, such as in mobile gaming, virtual communications and electronic signature solutions may be prudent. Even so, picking long-term winners in the technology sector — getting expensive by many analyst accounts — is difficult.

Whilst there has been a broad recovery in the S&P 500 since the lows on 23 March, the recovery within pharma stocks is more nuanced and has been influenced by companies’ Q1 earnings results, perception of the value of existing pipelines in a post-pandemic world, as well as the potential to deliver meaningful innovation over the timeline of the pandemic. Here, the current and potential outlook for the stocks of a selection of pharma majors are evaluated, with an overall outlook that the sector may be the best area yet for investors to buy.

Pharma majors’ Q1 results show a broadly positive picture but stocks have a fractured outlook

Johnson & Johnson (NYSE: JNJ) is the largest and most diversified healthcare company in the world and analysis of its Q1 results shows the sales up 3.3% in first-quarter 2020 over the prior year with an increased Q1 profit margin of 28% over the prior year resulting from lower expenses. This has been accompanied by a stock which has shown a modest 2% gain in 2020. The increase in stock price has been complemented by the fact that Johnson & Johnson also pays a 2.7% dividend yield, higher than the average 2% payout of S&P 500 stock and which was increased by 6.3% in April for the 58th year.

However, with lawsuits relating to opioids, talc baby powder and other areas, investors could have argued a mixed outlook for Johnson & Johnson in 2020. The firm’s efforts in response to the coronavirus pandemic may make the outlook more certain. Johnson & Johnson was one of the first companies globally to reveal its efforts on a coronavirus vaccine, working with the Biomedical Advance Research and Development Authority, a division of the US Department of Health and Human Services. Dr. Paul Stoffels, Chief Scientific Officer of the healthcare giant has stated that the company is aiming to produce one billion coronavirus vaccines in 2021 and is currently preparing for clinical trials in September. Stoffels states that “we will have some vaccine available this year, but it will depend on the authorities – the FDA and others – to decide whether it can be used earlier before efficacy data are available.”

Performance of Johnson and Johnson S&P 500 price change compared to majors in the airline, energy sectors

The number of elective procedures conducted by the company are expected to slow the growth of the medical devices business, although this may be a near-term problem as patients return to procedures in 2021. More long-term, the oncoming recession may cause a reduction in drug sales growth as was in the aftermath of the 2007 financial crisis. From the 23 March S&P 500 lows, J&J stock is up 34.16% and its consensus among 20 polled investment analysts has remained a buy, steady since April. Interestingly, following Q1 results whilst analysts generally upgraded their earnings per share estimates, there has not been a dramatic change to revenue forecasts or the 12-month $163 target price, reflecting confidence in the intrinsic business.

Gilead Sciences (NASDAQ: GILD) is a pharmaceutical company which has gained attention for the apparent success of Remdesivir, the antiviral drug, which in clinical trials has shown some success in treating patients with COVID-19. The firm’s stock is up 11.28% since the lows on 23 March, helped by the news surrounding Remdesivir which has now been given Compassionate Use Program (CUP) status. Compared with J&J, the firm’s quarterly dividend yield is even more attractive, at 3.5% and which has risen since the first payout in 2015, a year since Gilead’s annual net margin has never fallen below 18% and providing the cash flow for these generous payouts. Whilst all doses of Remdesivir on hand will be donated and won’t serve as a profitable avenue for the company initially, there could be a different picture long-term. With an ongoing pandemic, Remdesivir could generate sales of more than $750 million in 2021 and $1.1 billion in 2022.

Gilead – Share price (YTD)

However, as analysts have noted, there is a risk of reputational damage if the drug is not affordable for at-risk populations and low-income communities, in the shadow of Gilead’s PR crisis around Sovaldi in 2013, a life-saving hepatitis C drug. More immediately, Gilead’s HIV drug program has five blockbuster drugs (part of an HIV treatment portfolio which makes up 74% of total revenue) may serve as a more promising avenue for revenue growth. However, Gilead’s revenue sourcing from HIV drugs and Sovaldi have seen a decline, contributing to Gilead’s ~30% overall revenue fall over the last 4 years.

In the context of Q1 results, Gilead has performed well and has reported revenues beating the consensus of $5.55 billion, up 5% on last year’s Q1, partly attributed to the pandemic but could have been even higher if not for the R&D expenses rising 4% to $1.1 billion, due to increased testing and manufacturing for Remdesivir. Provided current HIV drugs deliver cash flow, and new drugs in the pipeline (such as immunology drug filgotinib targeting rheumatoid arthritis which is under priority review by the FDA to target a $20+ billion market) are successful, Gilead’s dividend payout may be sustainable and could increase demand for the stock.

Left to right: Revenue (2015-2019), Net Income (2015-2019), EPS (2015-2019)

There are risks to Gilead’s stock outlook, reflected in its high 31.8 P/E ratio compared to the market average of 18.4. Firstly, around the long-term demand for Remdesivir in an environment where billions of dollars are being invested in finding vaccines as well as numerous other treatments, which would reduce the need for Remdesivir in 2021. Indeed, Gilead has indicated that it could invest as much as $1 billion into the development of Remdesivir, which has raised some concerns. Whilst Gilead’s stock has still appreciated 23% YTD (in part due its major use of its $1.4 billion operating cash flow to buy back stock), impressively, even with $874 million dividend payments and $500 million debt reduction in Q1, the company still ended the quarter with $24.3 billion in cash, cash equivalents, and marketable debt securities. Given the risks, however, the outlook for Gilead stock is mixed and has contributed to the hold consensus amongst 30 polled investment analysts with a 12-month price target of 80 USD, just north of the current 79.65 USD trading position on 12/05/2020.

Interestingly, several reports have also drawn attention to the anti-malarial drug chloroquine as a potential treatment for COVID-19 patients. The German conglomerate Bayer (ETR: BAYN) has donated three million of these tablets to the US government but the drug is awaiting emergency use authorization. Like J&J and Gilead, Bayer also reported better-than-expected Q1 results, partly due to stockpiling of its drugs (such as the blood thinner Xarelto) in the first quarter, which grew the company’s sales by 4.8% to $13.94 billion. However, the firm’s stock has been struggling the past five years, with shares down by 65%. Further, Bayer has struggled with revenue and earnings growth and in contrast to other firms, Bayer has not provided full-year guidance owing to the effects of the pandemic. This is worsened by fact that the stock now trades ex-dividend for investors who purchased shares after 29th April and future dividend cuts are likely. This is surprising given Bayer’s 4.9% dividend yield payment over ten years.

One interesting comment from Bayer Chief Financial Officer Wolfgang Nickl has been that whilst all the company’s production sites are running, logistical costs have increased “substantially”. However, evaluating the previous guidance, Bayer had expected modest growth in sales across its three segments (3-4% for its pharmaceutical segment, 4% in crop science and between 2-3% in consumer health). Bayer had also expected its core earnings per share (EPS) for 2020 to grow to between 7-7.20, above the EPS of 6.40 euros in 2019. However, these projections were pre-pandemic. Other worries for Bayer include the 4.7% fall in Q1 sales of the age-related macular degeneration drug Eylea below analyst expectations. Whilst Bayer attributed this fall to withheld ordering in anticipation of Eylea pricing reductions in Japan and France, the firm does not expect to see any further impact for Eylea outside the U.S.

A more significant current concern for Bayer is around lawsuits against Roundup, a product line acquired during the noteworthy $63 billion takeover of Monsanto. The legal battle is against plaintiffs on the assertion that its Roundup weed killer causes cancer and since August 2018 have caused Bayer shares to fall more than 30%. Following three later cancer trials in California, combined damages of $191 million were paid out. Recently, the number of plaintiffs has increased from 48,000 to 52,500 but last month Bayer’s executive board won a clear vote of confidence from shareholders, with 92.6% support for ratifying the board’s 2019 business conduct. Whilst at least 6 settlement talks for Q1 have been put on hold, the company has still asserted that it will consider a financial solution which is “reasonable”, especially given the liquidity challenges the firm faces. Bayer’s financial situation can be assessed using two ratios: net debt/EBITDA (2.96 times) and net interest cover (4.88 times its interest expense). The latter point with interest cover is more concerning as lenders may place additional lending restrictions in future. The analyst consensus is more mixed for Bayer, but in the US the 12-month target price is 21.95 USD, north of the current 15.73 USD, where the stock is traded over the counter. 

Since the S&P 500 lows on 23 March, Novartis (NYSE: NVS and SIX: NOVN) stock has made a significant recovery and is up 22.15%. The less toxic chloroquine derivative, hydroxychloroquine, is still undergoing experimentation to establish whether it is a treatment for coronavirus. Novartis has committed to donating 130 million doses of this derivative. In the latest call, the firm also stated that it does not see COVID-related efforts would hindering margin progression. In particular, healthcare systems and therapeutic areas are expected to receive a recovery going into Q2 2020. The company has also entered the COVID-19 Therapeutics Accelerator led by the Bill and Melinda Gates Foundation, for the mission of funding antiviral drug innovation. As a result, both Bayer and Novartis may gain from the use of chloroquine and hydroxychloroquine globally, but, as mentioned in the case of Gilead, the potential for a vaccine or more effective treatment could prevent any gain.

Novartis – Share price (YTD)

One factor that had contributed to the rise of Novartis’ stock is its diverse portfolio of high-growth assets which had led to the company securing $48 billion in net revenue in 2019, a 9% increase year on year. Analysis shows that a significant segment of Novartis’ revenue trailed from its heart failure drug Entresto and its psoriasis drug Cosentyx. Most recently, Novartis’ dividend yield was 3.5%, further strengthening the case for the stock which it has a strong track record of improving year-on-year since 1996. Its diversified and strong revenue base is reflected by the uptake the stock has had with hedge funds. Hedge fund sentiment (a group whose assets have outperformed the S&P 500 ETFs by 41% since March 2017) shows that Novartis was in 30 hedge funds’ portfolios at the end of Q4 2019.

Novartis has been a popular bet for hedge funds

With regards to Q1 results, analysis of operational performance shows that Novartis’ sales grew 13% whilst the core operating income grew 34%. Further, the pipeline strength in Q1 showed some gain. Zolgensma (a gene therapy medication to treat spinal muscular atrophy in small children) already approved in the US by the FDA gained a positive CHMP opinion and Japanese approval as did Cosentyx for non-radiographic axial SpA. Ofatumumab and Inclisiran have also gained filing acceptance in US and EU and are expected to gain FDA approval, reflecting strong pipelines. These results may have contributed to the median analyst 12-month price target of 100.51 USD, up from 86.24 USD currently trading on the NYSE on 12/05/2020. 

Pfizer (NYSE: PFE) is one of the biggest and most diversified pharmaceutical companies and has seen its stock rise 32.68% since 23 March. Analysis of Q1 results shows that Pfizer sales fell 8% in Q1 on a continued decline off the four-quarter trend of declines as did earnings falling 6%. CEO Albert Bourla, however, expects the Upjohn-Mylan combination to instigate Pfizer’s return to sales and earnings growth, which was revealed in 2019, to form the new entity Viatris. This has been pushed back to this summer. The rationale for the merger was the generation of $19-20 billion in sales in 2020 whilst helping Mylan with lapsing generic-drug sales in North America. The new project should allow Pfizer to reverse revenue decline. Pfizer stock is up 32.68% since 23 March. However, for investors there remains a lot of risk, particularly that the company is expected to lower its dividend yield following merger, down from its industry leading 5% yield. Current Pfizer shareholders are expected to continue receiving dividend payments from both Pfizer and Viatris which the company has stated together should be roughly equivalent to the current Pfizer dividend payout. However, spinning off Upjohn may also help remove Lyrica’s drag on revenue growth, a drug which lost patent exclusivity in 2019 resulting in a 67% fall in sales in Q4 year on year. The removal will also help Pfizer’s remaining portfolio to be retained with several blockbuster drugs, such as blood thinner Eliquis, prostate cancer drug Xtandi and rare-disease drug Vyndaquel. 

Pfizer – Share price (YTD)

Pfizer stock jumped nearly 7% on 17 March following news of its co-development of a coronavirus vaccine with BioNTech SE (Nasdaq: BNTX) for an innovative mRNA vaccine, with clinical trials first occurring in the US on 5 May. Reports show that the company has a team of nearly 75 scientists and engineers at the 1,300-acre Kalamazoo manufacturing campus in Michigan who are constructing a manufacturing line for mass production of a vaccine for COVID-19 as soon as Q4. The firm aims by Q3 to show proof of vaccine formulation and packaging with manufacturing for commercial use beginning in Q4. As with other pharmaceutical companies, however, these timelines depend on many factors, including the success of the clinical trials and speed of approval from the FDA. Under an optimistic timetable, with these facilities millions of vaccine doses could be produced in 2020, and hundreds of millions in 2021. Outside of Eliquis, Xtandi and Vyndaquel the pneumococcal vaccine Prevnar 13 has seen sales rise owing to its use to treat severe cases of pneumonia resulting from coronavirus. The stock is currently trading around 12 times expected earnings, which may be undervalued once the Upjohn-Mylan deal closes. Given the option to sell Viatris shares following the transaction, already a strong drug maker, Pfizer may be a strong buy for income-seeking investors. This may have contributed to the analyst consensus to buy the stock, with a 12-month price target of 41.50 USD, up from the 37.6 USD on 12/05/2020.

In the latest earning call, AstraZeneca (NYSE: AZN) reported total revenue advancing 17% and foresees a low to mid-single-digit revenue benefit from COVID-19 whilst core operating profit grew by 16% and sales in China grew 17% against 35% the year before. Q1 2020 saw the sixth consecutive quarter, for which strong total revenue growth was seen. In Q1 2020, this was especially driven by new medicines such as Tagrisso (added more than $350 million in revenue alone), Imfinzi, Lynparza. Further, new medicines such as Fasenra, Farxiga, Brilinta and now Calquence have added a total of $1 billion in sales. Calquence, a blood cancer drug has been repurposed by the company to treat seriously ill patients COVID-19 patients who suffer from an immune overreaction. Other major pharmaceutical giants are testing potential treatments. Roche been trialing its anti-inflammatory Actemra to alleviate cytokine storm in COVID-19 patients and its IL-6 inhibitor rival whilst Eli Lillyhas been testing Olumiant, its rheumatoid arthritis drug to treat patients hospitalized with COVID-19.

AstraZeneca – Share price (YTD)

More interestingly, AstraZeneca unveiled a partnership with the University of Oxford to oversee the global manufacturing, development and distribution of the vaccine candidate ChAdOx1 nCoV-19 created by university researchers, which have progressed to human clinical trials. The partnership aims to produce 100 million doses by the end of 2020. News of the agreement has sent AZ shares soaring, now almost 40% from the S&P 500 low on 23 March. In concert with the oil crisis, the news has meant that Royal Dutch Shell has been toppled by AZ as the UK’s most highly valued company.

AstraZeneca has been another popular hedge fund bet

Bristol Myers Squibb (NYSE: BMY) has seen its stock rise 34.50% since 23 March. Bristol also pays a dividend of 2.9%, higher than the S&P 500 average and which has grown 9.8% following the $74 billion acquisition of biotech giant Celgene last year. Celgene’s cancer treatments Revlimid, Opdivo and the blood thinner Eliquis have become BMS’s biggest sellers. This year’s stock rises are also due to Bristol’s combination “Opdivo plus Yervoy” treatment, regarded as a milestone for lung cancer patients, as well as for pleural mesothelioma cancer caused by asbestos. Pleural mesothelioma cancer survival rate has significantly improved and, as the further clinical trials pass to 2021, if further promising results hold, the stock may perform well. Some analysts have regarded BMS as a coronavirus-proof stock stemming from the fact that the company’s three most profitable lines (Eliquis for blood thinner, Opdivo for immunotherapy and Orencia for rheumatoid arthritis) are expected to be sustained over the pandemic. The Celgene acquisition has also brought blockbuster drugs Revlimid, Pomalyst, and Abraxane into Bristol’s portfolio, drugs whose sales have also been immune to the pandemic. 

Bristol Myers Squibs – Share price (YTD)

Evaluation of the company’s financials also suggests positive news. Investors will notice that BMS has a PEG ratio of 1.09 compared to the PEG industry average of 2.09. PEG is a ratio which takes into account a company’s expected earnings growth rate as well as its P/E ratio. Further, BMS’s the P/B ratio (a valuation metric which compares stock price against book value) is also attractive at 2.67 against the industry average of 6.84. These factors have contributed to a consensus amongst value investors and analysts that the stock is undervalued right now, with a 12-month price target of 73.00 USD against the closing price on 12/05/2020 of 62.77 USD. As a result, BMS currently holds a consensus buy.

Diagnostics investing shortfall shows results 

Whilst investors have flocked to technology, healthcare and pharmaceutical companies owing to their differentiated ability to continue operating during the ongoing pandemic, deficiencies in other industries have been exposed. One interesting point is the diagnostics industry, which has traditionally been underinvested compared to pharmaceutical groups. Evaluation of funding by private equity shows that in 2018 and 2019, there was an eight-fold gap between the investment received by diagnostics start-ups and pharmaceutical firms.

But the current pandemic has shown the consequences of this chronic under-funding. In particular, the lack of testing capabilities has intensified the conversation around the relative value the market has placed on diagnostics compared to therapeutics. To further complicate a response from the largest diagnostics firms, such as Thermo Fisher and Danaher, there is a risk that an investment into diagnostics may not yield a long-term result after the pandemic. From 23 March, Thermo Fisher and Danaher stock have appreciated 30.65% 32.40%, respectively. Thermo Fisher reported a first-quarter revenue of $6.23 billion, a +2% increase on the prior-year period revenue and beating analyst estimates. CEO Marc Casper, CEO noted that, “the COVID-19 pandemic has put a spotlight on the importance of the work we do at Thermo Fisher Scientific.”

The most interesting innovations within diagnostics come from synthetic biology and Crispr-based diagnostics. One of these firms is Mammoth Biosciences, co-founded by Jennifer Doudna, which in partnership with UCSF has developed a high-throughput CRISPR-based methodology to diagnose COVID-19 in 30 minutes, without the need for a lab. Continuing to develop these rapid tests will be key, as concerns over a lack of vaccine availability at any given moment will result in the need for diagnostic detail to inform where to target the vaccine in virus hotspots. 

A developing picture 

Whether the pharmaceutical and broader healthcare sectors remain resilient will depend on a range of complex factors and at present both areas see significant inflows. For the healthcare sector, analysts have noted that asset-heavy companies with significant inpatient operations will suffer against more outpatient operations and those which have diagnostic testing.

Analysis of ETF weightings relative to the S&P 500 shows significant movement to these two areas. Momentum investing reflects the belief that certain stocks in periods of strong uptrends have the capability to continue rising.

Momentum ETFs show shift towards healthcare and technology sectors

These two sectors continue to provide significant lift to the three major U.S. stock indexes as well as to the tech-heavy NASDAQ and on 11 May of the 11 major sectors in the S&P 500, whilst four closed down, healthcare (SPXHC) showed the biggest gains.

As the discussion in this commentary show, the key factors determining whether a pharmaceutical company’s stock has a resilient outlook are:

  • The value of the existing pipeline in the context of a pandemic and post-pandemic world
  • Q1 earnings and the guidance for FY 2020
  • Innovative responses to the coronavirus pandemic, whether treatments or vaccines

With investors looking to participate in the recovery given the massive fiscal and monetary stimulus, there is optimism that the pharmaceutical stocks may be reigniting the trend following the 2008 financial crisis, which led to significant stock growth up until 2015. Nonetheless, the outlook is not certain: despite the apparent positive correlation between the coronavirus pandemic and pharma returns, this sector is nonetheless a highly risky business, with frequent bouts of volatility. A staggered investment in pharma funds over the next months, informed by the three metrics above, may be the best approach going forward.

Solomon Pervez is the Vice-President of UCL Investment Fund. Previously, he served as Biotechnology Portfolio Manager at UCLIF. He is also a BSc Biochemistry and Incoming MSc Bioscience Entrepreneurship student at UCL.

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