Alex Morozov: Hi, I'm Alex Morozov, the associate director of the health-care team here at Morningstar. With some sort of health-care reform imminent in the near future, the pharmaceutical sector is viewed by many to have a target on its back. With me is our senior pharmaceutical analyst, Damien Conover, to discuss potential reform proposals and the impact it will have on the pharmaceutical stocks.
Damien Conover: Thanks for having me, Alex.
Morozov: While the pharmaceutical sector is a favorite target for everybody, it seems that the current proposals being floated out there kind of lack punch a little bit. Can you talk about that?
Conover: Yeah, I agree with you. Like you said, pharmaceutical firms are definitely a big target. But it looks like what's going to happen to the pharmaceutical firms is it's like they may get hit more with a slingshot rather than a big rifle. It looks like it's going to be manageable.Read Full Transcript
So what I mean by that is that there are two things that I think a lot of investors were worried about with pharmaceutical firms. One was reimportation of drugs from other countries that price drugs much more cheaply, and two, direct negotiation for drug prices for Medicare Part D patients. It looks like both of those are pretty much off the table, or at least are going to be done at a much lower level than what was feared.
Morozov: What has the pharmaceutical sector done to potentially diminish the impact of the health-care reform?
Conover: Yeah, it's a good question. Pharmaceutical firms are not standing idly by. They're going to try to head off government at the pass here with their own plan that they've proposed.
So what they've proposed is an $80 billion initiative that would help reduce costs over the next 10 years. And that's two pieces. About $50 billion of that would go to just reducing costs in general. And $30 billion would help fund patients who are on Medicare Part D who get into this doughnut hole, which means, if you start to spend a little bit of money, as soon as you get to a certain level, you're not reimbursed, and then you have to get to another level before you're reimbursed again.
What pharmaceutical firms are planning to do with the remainder of that $80 billion is help fund that little, small piece there. So, pharmaceutical firms are there. They've got their own plan out there, but it's much more easily digestible than some of the worst fears that were in the market.
Morozov: But didn't pharmaceutical companies already help fund that doughnut hole, in some way?
Conover: Yeah. It's a little misleading in that there was no funding there before. They have assistance programs for people who are very poor, but this goes even beyond that. This really reaches out to the people who actually do have sizable amounts of money, but they will be helped in this small piece of the reimbursement pie.
Morozov: Well, $80 billion still seems like a drop in the bucket for some of those pharmaceutical companies. What about a worst-case scenario? What if you have a single-payer system in the United States that unilaterally can dictate prices, and we see an across-the-board cut in Medicare reimbursements, for example?
Conover: Yeah. Well, I think the worst-case scenario even goes beyond just Medicare reimbursement. I think, if you went to a single-payer plan, you would just see everybody getting the cuts across the board. And that would be devastating for pharmaceutical firms.
From our analysis, we've done a little bit of scenario analysis, and it might take about 30% off of our fair values. And right now, our fair values are trading at about a 25%-30% premium. So, basically, if the worst case were to materialize, we would think pharmaceutical firms are, basically, fairly priced.
Morozov: What is your, I guess, more likely prognosis for the pharma sector?
Conover: What we think is likely is that we're going to see some more price sensitivity on the Medicare Part D patients. Now, keep this in mind. This is about 20% of the drug spending here in the US. And we would expect a lot of that pricing power that pharmaceutical firms used to have will diminish greatly. So we think that could be a slight haircut to the overall pricing power of pharmaceutical firms. And in that case, we would see, likely, about maybe a 5% loss on their revenues, which is what we currently have factored in to our fair values.
Morozov: But in any case, the expectations that are baked in in the current prices of many of those pharmaceutical stocks, essentially, expect the worst-case scenario.
Conover: Yeah, I think so. I think they expect the worst-case scenario. And I think that's a good opportunity for investors to benefit from. I think investing in pharmaceutical firms right now is very good, because it's likely we'll see some passage by later in this year, and that passage will probably be not as bad as what the market anticipates and beneficial for anybody that gets in the pharmaceutical stocks right now.
Morozov: Removing, potentially, a negative catalyst.
Morozov: OK. Thank you, Damien.
Conover: Great. Thanks, Alex.