Pharmaceutical sector- achieving an edge by managing risk

Posted on Saturday 28 November 15 | Category: Investments & Life

The last couple of years the market has been gung-ho about all the sales growth coming from pharma company exports to USA. In fact any company that had low share of sales to the US market had a dramatically different (lower) valuation band compared to the companies with greater presence there (USA). 1)This is in spite of the greater earnings stability of the former (low US market share companies) from a regulatory perspective. In addition:2)Retail pharmacy chains  in USA are far more consolidated (with a few large players making up majority(~80%) of the market), than anywhere else in the world, hence you are playing a lowest cost game with group of large and knowledgeable buyers;3)The consolidated nature of retail pharmacy chains, in a way also reduces barriers to entry;4)Unless of course a company has  a first to file which gives it six months of selling exclusivity and some head start in the market as a brand. Even then there are always USFDA data or manufacturing audits that can upset the apple cart, when the company is rushing to be the first and could make some mistakes(i.e  inadvertently take short cuts) .

In face of such clear risks, buying the most popular pharma growth story, comes with its risk ,as the stock of one of largest market cap company’s clearly showed with a correction of  almost 30% from the top of March 2014 to now (due various concerns like a possible growth slowdown and a rare special audit ordered by the USFDA). Another large cap company in the sector similarly had its stock fall 21% in one month on adverse USFDA observations.  Factoring these business risks appropriately, depending on the company under consideration, therefore buying only when there is a margin of safety tends to protect downsides, and puts you and your portfolio in a favourable situation with respect to returns in a business cycle  of 5-7 years.

Dinesh da Costa, CFA

“Investment edge through risk management

Please note information given above is not a recommendation to invest, but an educational illustration.

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