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Election Win for Drug Makers?

November 14, 2018

One of the significant campaign themes for the Democrats in the midterms was a focus on healthcare. Even as  Republican candidates voiced repeated calls to defend insurance coverage for pre-existing conditions and working on lowering prescription drug prices, Democratic candidates ran numerous ads challenging the efficacy of those calls.

We now have a divided Congress, with Democrats in control of the House and the GOP controlling the Senate. And this is viewed as a positive for many healthcare stocks, particularly the drug makers.

Drug companies and their lobbyists view the gridlock as opportunity to table various initiatives to place pricing restrictions or other measures to limit margins on their products. In turn, while Congress is locked, the industry will focus on the Trump Administration and the Department of Health and Human Services (HHS) to both limit price controls and speed up approvals by the Food and Drug Administration (FDA) for new drugs as well as additional approvals on new uses for existing products.

With price reforms tabled, the industry will also be geared up to work on scaling back any initiatives to reform Medicare Part D. Pricing controls are out of the question without legislative support in the Senate. And if anything, the so-called donut hole in the plan (the coverage gap that comes in after a certain amount of drug benefits are paid out, until coverage is resumed at a higher level of drug benefits) may finally be closed, which would work to increase drug sales to eligible seniors and benefit drug companies.

Then we come to Medicare Part B. The Trump Administration voiced some interest recently to limit what Medicare would pay for drugs. But without being able to pass legislation, this may well remain tabled for now.

Lastly, the issues involving pharmaceutical benefit managers (PBMs) and the rebates they pay to contracted insurers might move along. This may well find support from both sides of the political aisle, as it would level the pricing in the drug market. And while on the surface this might seem to work against drug makers’ margins, I see it as reducing overall costs of drugs while not impacting manufacturers’ margins, since it would cut out the middlemen in the market—the PBMs.

The market for healthcare and drug stocks continues to be outperforming the general S&P 500 Index for the year. For the troubled month of October, the healthcare market (as tracked by the S&P Healthcare Index) and the general S&P 500 were largely in line in terms of losses. However, after the election last Tuesday, the healthcare index has outperformed by a factor of over three to one. The S&P Healthcare Index has posted a return year to date of 13.72% against the S&P’s 5.74%.

Two of my favored drug companies are Merck (MRK) and Pfizer (PFE).

Merck has been a great performer, with a year to date return of 37.30%. It pays a dividend of 55 cents, which was just raised, and yields 2.92%. The company is one of the industry’s leaders in prescription drugs, vaccines, and biologic therapies as well as pet health and consumer products.

This company has turned around its revenue growth for 2018, and I see it continuing on track. The most recent quarter saw gains of 4.54%. Operating margins are ample at 16.30%, which is driving a good return on shareholder’s equity at 10.00%.

Merck has plenty of cash on hand, and its credit capabilities to fund further development are good, with a low debt to assets ratio of 27.80%.

And while the price to book is a bit higher than for the median of its peers, at 6.18 times, its book of patents and its pipeline for new products remain good sources of value.

Pfizer has turned in another great market return, with the year to date showing 26.32%. The company is similar to Merck, with its own lineup of prescription drugs, vaccines, medical devices and consumer healthcare goods.

Revenues for the company have been back on the ascent for 2018 after a disappointing 2017. But the gains have trailed the growth of Merck, with the most recent quarter only seeing gains of 0.99%.

However, operating margins for Pfizer are better than for Merck, at 25.90%. And this in turn is delivering an even better return on its shareholder’s equity, at 36.10%.

Its credit profile is similar to Merck’s, with good cash on hand and a low debt-to-assets ratio of only 25.30%. This provides the company with a great deal of flexibility for further investment for growth.

The stock is valued a lot cheaper than Merck, with a price to book at only 3.60 times, making for a better bargain. The dividend is also good, at 34 cents, which is up in distribution this year by 6.25%, in line with the five-year average annual gain in payouts of 7.21%. The yield is 3.06%, again better than for Merck.

Both Merck and Pfizer should continue to see further gains into 2019, and they should, if anything, see gridlock as a positive and perhaps see some positive help from the Administration in regulatory treatments.

Both should be considered dependable drug stocks for dividends and growth.