Pharma’s Q2 Earnings Lesson: The Big Picture Looks Good

Philosophically speaking, earnings season is about learning how well or poorly individual companies did — and how well or poorly the overall market did — for the quarter in question. The former’s a micro look, while the latter’s a macro look. Both are important.

There’s an in-between look, however, that investors tend to miss even though it can be just as important as the company-specific and market-wide picture: sector-level results. It matters, because sector-peer influence makes up about 40% of an individual stock’s performance.

Translation: If you can pick the right sector, nearly half the battle is won.

And what sector could be more worth exploring right now than the pharmaceutical industry? The group’s in the midst of falling off a patent cliff, yet some of these names have countered key acquisitions and new drugs. What can we learn — if anything — from the industry’s overall performance in Q2?

The Bigger Picture

If big pharma is hitting a wall, somebody might want to tell those companies that. As a group, the world’s 11 biggest pharmaceutical manufacturers only reported a very minor dip in Q2’s operating income. Even more impressive is that these companies have collectively beaten their earnings estimates by a tad more than 5% for the second quarter. In fact, only one missed: GlaxoSmithKline (NYSE:GSK).

That’s not to say it was all sunshine and roses. In terms of a year-over-year comparison, it was an all-or-nothing proposition, with the bottom line’s growth or contraction likely to be a big number either way. Four of these names posted earnings slides, and the other seven saw an earnings improvement. Of those seven, however, only four could be considered strong improvements.

Still, given the challenges (and the fact investors have been assuming the worst), if it were a student, big pharma would have to be given a solid “B” for the second quarter.

There’s still more to the story, though.

Breaking It Down

While numbers tell part of the tale, to really get a sense for where the major pharmaceutical names are headed as group, you have to dive deeper into the earnings reports and look for common themes. There were/are some blaring ones for Q2.

First and foremost, pharmaceutical companies are noticing the toll that generics are taking on sales of drugs that have recently lost patent protection. Sales of Plavix, which is Bristol-Myers’ (NYSE:BMY) top-selling drug, fell by 60% after its patent expired in May. Revenue was off by 18%, but had it not been for the loss of exclusivity on Plavix, the company estimates that sales would have grown by 8%. Pfizer’s (NYSE:PFE) Lipitor also lost its patent protection a few months ago, leading to a 53% dip in the second quarter’s Lipitor revenue, to $1.22 billion. The drug’s sales fell nearly 80% in the United States.

Yet, Pfizer caught more than a few people off guard with good news. The pharma company still managed to crank up the bottom line by 25%, even with the negative impact of waning Lipitor sales.

And Pfizer wasn’t alone on the head-turning front.

Although it’s unlikely any drug will match Lipitor’s success, many of these companies have been working pipelines that are more marketable than the companies have been getting credit for.

Take Eli Lilly’s (NYSE:LLY) Cymbalta, for instance. Although the company saw income plunge 23% in Q2 thanks to anti-schizophrenia drug Zyprexa “going generic” last quarter and setting up a 73% decline in its revenue, Cymbalta sales grew 22% to $1.22 billion in Q2. For perspective, Lilly generated revenue of $5.6 billion during the second quarter.

Novartis AG (NYSE:NVS) was another name that managed to offset losses to generic competition with other, patent-protected drugs in its portfolio.

Diovan (for high blood pressure) lost its patent protection in Europe, inflicting a 16% hit on its global sales, and falling to $1.3 billion. Yet, Novartis also saw a handful of relatively new drugs more than offset Diovan’s loss. Afinitor, Tasigna, Gilenya and Lucentis — all of which have been introduced within the past five years –- collectively posted sales of $4.1 billion. That’s 8% better than the group did last year, and the newest name in the bunch — Gilenya (for multiple sclerosis) — was only approved in Q1 and hasn’t had much time to develop any real sales momentum. The company thinks it also could become a billion-dollar annual drug.

Bottom Line

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None of these new drugs will ever be on par with the likes Lipitor, Merck’s (NYSE:MRK) Singulair, or most of the big-time blockbusters. Thing is, a year or two ago it wasn’t clear if any of these companies had anything in the works that could even come close to replacing the lost revenue stemming from expiring patents, justifying the market’s fear of the group as a whole.

Now though, the pipeline veil is being lifted. It might not be pretty, but some of these companies do indeed have workable solutions to replace lost revenue. On the flip side, others do not. But, that’s OK, because if you look closely, this group of stocks isn’t moving as a herd — for better or worse — the way it was yesteryear. Now the market is separating the men from the boys.

Said another way, though the group as a whole still is a little lethargic, owning one or two select names in the group isn’t automatically a liability any longer. Now, the market is starting to reward real success and penalize weakness — just like it should.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

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