Winners and losers in Big Pharma shares

China's hard landing and a plunge in crude oil will trigger another Wall Street sell off in early 2016 as the Fed hikes interest rates.

Big pharma is often eclipsed by the spectacular boom bust cycles in biotech, the high-beta, frontier segment of global healthcare. Big Pharma excites me because investors can make serious money if they take the trouble to research its pipeline, products and value catalysts. For instance, even though the index is flat, Eli Lilly shares have surged 20 per cent in 2015 mainly due to its pipeline of diabetics, psoriasis, arthritis, Alzheimers and breast cancer drugs, all of which promise to be billion-dollar blockbusters after they receive final FDA approvals next year. Alzheimer's, diabetes and arthritis are three of the world's largest high-growth therapeutic markets. Of course, Eli Lilly now expensive at 21 times earnings but EPS growth will more than compensate for an optically expensive price.
I still believe China's hard landing and a plunge in crude oil will trigger another Wall Street sell off in early 2016 as the Fed hikes interest rates. In an expensive market, I expect megacap Big Pharma shares could well prove profitable safe havens for investors, thanks to reasonable valuations relative to earnings growth and often three per cent-plus dividend yields. Yet there will be winners and losers in Big Pharma in 2016.
Pfizer is the world's largest pharmaceutical company, with a market cap of $205 billion even without Allergan. Pfizer at 32 trades at 15 times forward earnings and a 3.5 per cent dividend yield. After five years of revenue declines due to its Lipitor/Celebrex patent expirations, 2016 could be the first year when revenues actually rise, thanks to a pipeline of 80 drugs in development or FDA-approved therapies. This means it is realistic to expect Pfizer to deliver 11 per cent or even 12 per cent compounded EPS growth in the next three years. This will, I believe, lead to a valuation rerating in the shares, even as CEO Ian Read cuts costs and forges new alliances/royalty agreements. Pfizer is a deal stock and the grapevine contends the world will see all stock swap with Irish Botox vendor Allergan next week. This tax inversion deal will face regulatory risk, which could well cause Pfizer to fall to 30. This could be a strategic opportunity to accumulate Pfizer.
Glaxo SmithKline is Britain's preeminent global pharma but its shares have been dead money for the past two years as it struggled with a patent expiration cliff and a corruption scandal in its China dealer network. Yet traditional pharma is now only one-third of global sales, with the growth ballast being vaccines and consumer health, with Advair a crown jewel brand. Glaxo's purchase of Novartis' vaccines business has created a global powerhouse. Respiratory and antivirus drugs will dominate the drug pipeline. The £3 billion cost synergies and new management in consumer health will accelerate margin expansion. The stellar six per cent dividend yield is resilient. Valuations at 15 times forward earnings are still at a discount to Novartis and Abbot Labs, which trade at 18 times earnings. My ideal buy/sell range for Glaxo's New York ADR is 38-48 next year. My biggest concern remains its below peer A+ credit rating due to higher debt leverage. This could lead to reduced stock buybacks if management decides to deleverage. After all, the dividend now consumes virtually entire free cash flow, though the Novartis deal was a cash windfall.
Immuno-oncology is the newest, most exciting therapeutic paradigm in humankind's ancient battle against cancer. Credit Suisse's pharma analyst team believes the global immunotherapy market will be $42 billion, a strategic argument to own Bristol Myers, Merck and Roche. Bristol Myers was an ideal buy in the September market hit at 58 and I am reluctant to buy the shares near its 52-day highs at 70. It is no coincidence that Bristol Myers shares have doubled since it launched its first melanoma immuno-oncology drug Yervoy three years ago. Immuno-oncology has given Bristol Myers a premium valuation multiples it so richly deserves. I can envisage Bristol Myers trading in a 58-74 range in 2016.