In May, the Trump administration released a blueprint for its plans to reduce the price of prescription drugs. The first sentence was “A BURDEN ON THE AMERICAN PEOPLE: Drug prices are being driven up unfairly, taking a toll on the American people.”
The plan seeks to increase competition in the market for prescription drugs and was seen as a shot over the bow of pharmaceutical manufacturers.
It’s long been argued that profits in the pharmaceutical sector fuel the research and development of newer and better treatments. Manufacturers explain that the high price tags on new and in-demand drugs finance even newer and better drugs that improve health outcomes and save lives.
Philosophical and political factors aside, savvy investors understand that the U.S. government accounts for 40% of all dollars spent on prescription drugs in the Medicare and Medicaid programs. With president Trump demanding lower prices and more competition in the industry, it would appear to be a challenging climate ahead for pharmaceutical manufacturers, but the latest quarterly earnings reports at Merck (MRK) and Amgen (AMGN) suggest that the best managed pharma companies are still performing quite well and have adeptly adjusted their strategies to survive and thrive in the current environment.
While a drug is still on patent, manufacturers retain a great deal of pricing power and many of them have been quite adept at gaming the system to keep prices higher even after the original patent protection might have expired. The new Trump plans seeks to make generics available more quickly, so companies that have a wide array of on-patent drugs are likely to hold onto better margins than smaller companies who are dependent on one or two “blockbusters” that may become vulnerable to cheaper competition.
Here is the revenue breakdown by drug in Amgen’s last quarter:
And here’s the breakdown at Merck:
As you can see, revenues at both of these companies are spread across a wide range of proprietary formulations. This is likely to insulate them from attempts to lower prices in the industry by streamlining the generic approval process.
Large drug companies are also defensive to larger economic trends. Consumers can choose not to purchase more discretionary items, but when you need medicine, you pretty much need it no matter what. AMGN and MRK both have a long history of steady earnings growth in all economic environments. The chances that they will have blowout quarters and huge rallies is fairly low, but so are the chances of a big miss and a fast decline.
These slow-and-steady giants are also a value proposition with forward P/E Ratios of 14X and 15.3X, respectively. And they dividend performers with Amgen currently yielding 2.7% annually and Merck yielding 2.9%.
For the health care portion of an investor’s portfolio, both of these Pharma giants provide stable growth, good value and income and are likely to survive drug-price reform efforts quite nicely.
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