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Stock Strategist Industry Reports

Finding Moats in Big Pharma's Consumer Health Units

We believe breakups could unlock value for big pharma shareholders.

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Over the next three years, pharmaceutical firms face a looming patent cliff. For this reason, segments of big pharma firms outside the prescription drug group, such as consumer health, are becoming increasingly important. In contrast to the prescription market, consumer healthcare products don't face the volatility associated with patent losses. Many consumer healthcare products actually gain in intrinsic value over time, instead of losing value in the prescription setting, as drugs approach patent expiration. As a representation of total sales (of the big pharma firms that have consumer health units), we estimate that by 2015, the consumer health segments' share of the pie will increase to 15%, reflecting an increase of 2% from current levels. Based on both the strong moats in this industry and the low overall valuations ascribed to big pharma firms in aggregate, we believe the investment community is underestimating the value that these consumer segments bring to the table.

Brand Names Demand Premiums in the Over-the-Counter Market
The primary competitive structural advantage in the over-the-counter, or OTC, market, is branding. Given the high importance and complex nature of treating one's health, brand names become particularly important in conveying both trust, and quality. Since most consumers lack a strong understanding of their own healthcare problems, they demonstrate a pronounced willingness to pay up for a product that carries a well-known brand. As a result, brand power is instrumental to creating moats in the OTC market, offsetting a relative lack of other structural competitive advantages.

David Krempa does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.