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Cost-Cutting Boosting Pharma Earnings

Jeremy Glaser

Jeremy Glaser: For Morningstar, I am Jeremy Glaser. We're half way through pharma earnings season, and I am here with associate director Damien Conover, see what we've learned so far and what we can expect in the other half of earnings.

Damien thanks for joining me today.

Damien Conover: Thanks for having me Jeremy.

Glaser: So what have we learned in this first half?

Conover: So, so far we have got about half the companies reported, and I think we're seeing a few things materialize. I think it's important for the rest of the group and the industry as a whole. First off, we're seeing a lot of cost-cutting. So as big pharma firms start to approach their patent cliff, they are getting very lean which I think is going to be important because they are losing a lot of the big revenue contributors, and that will be important. We see them positioning themselves very well.

Secondly, I think one of the big concerns coming out of this quarter was how Japan might influence the big pharmaceutical companies. So far it hasn't been a big impact at all with about 3% to 9% of total sales coming from Japan, we were somewhat concerned that the horrible natural disaster there was going to cause some problems, but if anything we're seeing even more demand for product from the pharmaceutical side.

And then also, it's important to note that this is the first quarter where we're seeing U.S. health-care reform kind of weigh on earnings, and it has been a little bit of a drag. But I think people were anticipating that, and I think the firms are getting through it largely OK.

The last point I would make that's true not just for the pharmaceutical industry but for the entire U.S. marketplace is that the weaker dollar is really helping these firms report stronger earnings. So its a stronger top line and bottom line because of the weaker dollar along with these firms having so many sales coming from overseas.

Glaser: Let's take a look at some individual company results. Was there anything that surprised you so far in the quarter?

Conover: So far I think the one that probably surprised us, probably the most was Johnson & Johnson. J&J had a particularly strong quarter. We think we are very favorable on the name, and we think there is a lot of upside on the stock price. The quarter could be showing us a little bit of evidence that the shift in J&J is starting to materialize, meaning J&J has had a couple of weak quarters and finally we're starting to see an inflection point for increased demand for a lot of its different products across the group.

Glaser: Are they still struggling with some of the product-recall issues that they've had in the past?

Conover: Yeah, it's a good question. They are still struggling with their consumer health division. Now this is, as you mentioned, a group that's had a lot of recall issues. The manufacturing for these facilities probably won't be back on line completely until the beginning of 2012. So, that will cause a little bit of a drag for the group, but you have to remember that the comparable sales, the year-over-year comps, should be pretty easy for J&J because the recall really started in the second quarter of last year. So going forward it just gets easier for J&J with that troubled division.

Glaser: Did you hear anything interesting from Abbott this quarter?

Conover: I think so. Abbott I thought had a very solid quarter, very strong growth, and I think that really kind of reaffirms our outlook on Abbott. Abbott's our top pick within the pharmaceutical industry, and to see a very strong growth from the company just reaffirms our outlook. In particular, its top drug HUMIRA for rheumatoid arthritis continues to grow very, very quickly, and we still have very strong expectations for that drug

Glaser: How about Novartis?

Conover: Novartis had a very strong quarter, as well, and I think that company really speaks to the new pipeline emerging from big pharma. It just recently launched a new multiple sclerosis drug called the Gilenya, and this is I think going to be a sign of what's going to happen with a lot of these firms, these more niche-oriented drugs launching and doing very well.

Glaser: Let's a look at the earnings that are coming up. Is there anything that you are looking for or looking at particularly closely?

Conover: I think we are going to see more of what we have seen so far in the first half: a strong top line and strong bottom line helped partially by the weak dollar. I also think we are going to see a lot more cost-cutting and share repurchases. Several of the firms that have yet to report earnings are doing massive share repurchases. So, that won't really drive some of the long-term growth of the company, but it will help in reducing the share count and growing earnings on the bottom line.

Glaser: Damien, thanks for the update.

Conover: Thanks Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser.