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How ESG Risk Affects Pharma and Biotech Moats and Valuations

Morningstar and Sustainalytics offer complementary methodologies.

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When we incorporated environmental, social, and governance factors into our valuation analysis for Big Pharma and Big Biotech at Morningstar, we focused on material ESG issues, or MEIs, in the social realm, where we think these companies are exposed to the most ESG risk. Sustainalytics' business ethics, product governance, and access to basic services MEIs stood out as the key issues that could affect valuations for our top 18 Big Pharma and Big Biotech names under coverage at Morningstar. After analyzing pricing strategies, ethics-related inquiries, and product safety-related litigation at each of these companies, we have modified our models to include annual litigation expenses in our base-case forecasts and additional U.S. pricing reform-related sales hits in our bear-case forecasts. We've tied the magnitude of these headwinds to each company's U.S. exposure (which boosts litigation and pricing risk), reliance on price increases, U.S. price discrepancies versus other developed markets, and exposure to medicines targeting chronic, less severe diseases (which we see as more exposed to litigation costs). Our ESG analysis provides a comprehensive evaluation that supports our mostly wide economic moat ratings for the industry. Overall, Morningstar sees undervalued names Roche (RHHBY) and BioMarin Pharmaceutical (BMRN) as having the lowest exposure to ESG-related risks. We also like Gilead Sciences (GILD), Sanofi (SNY), and Pfizer (PFE) on both valuation and ESG risk. Johnson & Johnson (JNJ) and Eli Lilly (LLY) look the least compelling to us, based on litigation risk and valuation, while AbbVie (ABBV) and Biogen (BIIB) look undervalued despite high pricing risk.

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Karen Andersen does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.