Anyone waiting for Big Pharma to stumble on the industry's so-called "patent cliff" has been heartily disappointed. In spite of many high-revenue products facing patent expirations in the next few years, the group continues to be a top performer, lifting the health care sector to a market-beating 9% gain by the end of July.
That bullish movement has come as a surprise to many analysts and investors because of the industry's pending patent cliff, with more than $33 billion in patented drug sales set to expire in 2012 alone. This includes blockbuster drugs like Pfizer's (NYSE: PFE) Lipitor, which brings the company annual sales of $11 billion and Bristol Myer Squibb's (NYSE: BMY) Plavix, the world's top-selling medicine, which generated more than $7 billion in 2011.
But though the industry will face headwinds related to the impending patent expirations, world-leading pharmaceutical companies are still positioned for big gains on a number of other long-term trends. And investors can benefit in a big way as well.
Bull case for Big Pharma
In a report titled "World Population Aging: 1950-2050," the United Nations says global population aging is unprecedented in human history. The 21st century will witness even more rapid aging as medical technologies extend life expectancies, the U.N says. And by 2050, 1.5 billion, or 16% of the global population will be above 65 years old, according to the Central Intelligence Agency. These older citizens will likely require higher levels of health care, which will provide a tailwind to the industry and Big Pharma companies with a global reach.
Big Pharma has the advantage of benefiting from an intricate network of international markets that offer access to customers worldwide. These customer and distribution networks take decades to build, which provide the industry with a strong economic moat to fend off the threat of newer pharma companies that are still trying to gain market share and customer loyalty.
But Big Pharma has also experienced a wave of consolidation in the past few years, as industry-leading companies facing patent expirations look for smaller companies with more innovative products and ideas to juice their product pipelines. This includes French pharmaceutical company Sanofi-Aventis (NYSE: SNY) buying Genzyme for $20 billion, and Astra Zeneca's (NYSE: AZN) $1.3 billion agreement to buy Ardrea Bio Sciences. Acquisitions like these provide a big boost for Big Pharma companies looking for new sources of revenue.
Here in the United States, Obamacare is expected to be a short-term drag on the industry, with analysts projecting a 5% earnings decline on margin compression during the next few years. But beyond 2014, when most of the provisions go in effect, experts predict as many as 41 million people will be added to the national health insurance system. Health care demand is expected to skyrocket.
And finally, in a world of extreme political and economic uncertainty, the health care industry is traditionally less cyclical and sensitive to economic fluctuations, providing a dash of long-term stability in an increasingly volatile market.
But as one of the most technical industries, picking winning pharmaceutical and health care stocks can be incredibly challenging. An industry darling one year can easily hit the skids with an unexpected lawsuit or failed clinical drug trial. It's precisely why my favorite way to invest in the industry is through the Market Vectors Pharmaceutical ETF (NYSE: PPH), an exchange-traded fund that provides investors with exposure to 25 publicly-traded pharmaceutical companies.
While there are a number of competitors in the Big Pharma ETF space, the Market Vectors Pharmaceutical ETF has the lowest expense ratio at just 0.35%. Shares are also very liquid, with average daily volume of more than 140,000. This helps keep the bid-ask spread tight, enabling investors to get effective execution and reduce slippage. Take a look at the market-beating gains in the chart below.
PPH vs. S&P 500-Daily Chart
Risks to Consider: Patent expirations are a threat to the earnings growth of Big Pharma, as billion-dollar drugs lose exclusivity and are subjected to intense generic competition. For the time being, the industry has proven to be resilient, supplementing earnings with acquisitions and new markets. The regulatory environment will also create uncertainty, with the implementation of Obamacare set to fully take hold in 2014. That is expected to present a short-term drag to the industry, but longer term, higher health insurance volumes will likely drive demand for medical products and services.
Action to Take --> Big Pharma continues to see big gains in sales and earnings in spite of looming patent expirations. That's because the industry is proving to be quite resilient in the face of adversity, adapting to dynamic market conditions through international growth and building product pipelines through the acquisition of smaller competitors.
Michael Vodicka does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.
This article originally appeared on StreetAuthority
Author: Michael Vodicka