Three cheap wide moat pharmaceutical giants

Joseph Taylor | Morningstar 

Recently, I published an article on why the drug manufacturing industry is home to so many impressive moats. Today we’re going to look at three pharmaceutical companies that Morningstar analysts currently view as five-star picks.

Big Pharma’s big divide

This may be an over-simplification, but there seems to be a clear divide when it comes to pharmaceutical stocks. A have and have-nots situation, if you like, between the insulin companies that stumbled upon obesity drugs and pretty much everyone else.

In the former camp, you have Novo Nordisk (CSE: NOVO B) and Eli Lilly (NYS: LLY). The success of Novo’s Wegovy and Ozempic have propelled its shares 160% higher in the past two years. It is now Europe’s most valuable public company. Eli Lilly shares have tripled in the past two years. As well as rocketing demand for its weight loss drug Mounjaro, Lily’s big hope in the dementia space was recommended for FDA approval. Apart from Berkshire Hathaway, it is now the S&P 500’s biggest non-tech company by market value.

Then you have the other side of the coin. Pfizer (NYS: PFE) is down 50% from its vaccine-induced high in 2021. Roche (SWX: ROG) is down around 20% in the past two years, even after rallying a bit recently. Bristol-Myers Squibb (NYS: BMS) is down 50% in the last 18 months. I could go on. As well as the usual worries about high-profile patents running out, there have also been increased fears of tighter laws in key markets like the US.

Now for the good news.

According to our analysts, these beaten down prices spell opportunity for long-term investors. For an explanation of Morningstar’s Moat Rating and Fair Value estimates, please see the explainer paragraph at the foot of this article. And remember – a five-star Morningstar rating doesn’t necessarily mean a share is right for your portfolio.

Pfizer ★★★★★

Moat Rating: Wide
Fair Value Estimate: USD 42
Share Price 24/6/24: USD 27.24

Pfizer’s revenue from Covid-19 vaccines has fallen faster than investors expected. This has led Pfizer’s management team to pour cold water on the market’s expectations for revenue and earnings in 2024 and 2025. At the end of 2023, Pfizer bought cancer drug firm Seagen for USD 43 Billion in a bid to deploy some of its pandemic earnings and offset future patent losses.

Morningstar’s Damien Conover assigns Pfizer a Wide Moat rating due to its patented drug portfolio, economies of scale and powerful distribution network. Pfizer’s patent-protected drugs carry strong pricing power. This lets the firm generate high returns on invested capital and the enormous cash flows needed to fund new and upgraded treatments before generic competition arises. Pfizer’s huge salesforce also makes it an attractive partner for smaller drug firms with promising treatments.

While Pfizer holds a diversified product portfolio, there is some product concentration. Childhood vaccine Prevnar represents just over 10% of total sales excluding COVID-19 vaccine revenues. However, Conover expects lower than usual generic competition for Prevnar as it is a complex product with a relatively low price. Anti-blood clot pill Eliquis and breast cancer treatment Ibrance also represent close to 10% of sales each. Conover expects that over the long term, revenue from new products will mitigate the eventual generic competition seen by Pfizer’s key drugs. Pfizer’s operating structure also allows for cost-cutting following patent losses to reduce the pressure that generic competition has on margins.

Conover cut his Fair Value estimate for Pfizer shares after management’s latest update featured lower than expected forecasts. Nonetheless, his new Fair Value estimate of USD 42 per share is still considerably above Pfizer’s current share price of around USD 27. Conover expects fairly stable sales over the next decade as new products help offset older drugs losing patent protection. On the bottom line, he projects a slightly healthier annual growth rate as cost-cutting plans take shape. While they don’t feature in Conover’s model, further acquisitions could see the company's growth rate accelerate.

Roche ★★★★★

Moat Rating: Wide
Fair Value Estimate: CHF 379
Share Price 24/6/24: CHF 252.80

I added Roche shares to my retirement portfolio in early May. The company is home to world-leading diagnostics and biologics businesses. Biologics are treatments derived from living organisms like viruses and bacteria rather than small-molecule chemicals.

Morningstar’s Roche analyst Karen Andersen thinks that Roche's biologics-focused drug portfolio and leading diagnostics business give it a Wide economic moat. Much of Roche's moat in pharmaceuticals stems from its long relationship with Genentech, which Roche bought outright in 2009 having been the majority shareholder since 1990. Genentech has a portfolio of blockbuster cancer biologics that continues to grow. Its researchers collaborate closely with those from Roche’s diagnostics business, boosting the efficiency of Genentech’s R&D and helping them form new and more personalised treatments.

Roche has seen revenue for its blockbuster Rituxan, Herceptin and Avastin drugs fall significantly since 2019 due to competition from biosimilars. Andersen expects sales for these three drugs to fall further but believes other parts of Roche’s portfolio can mitigate this. Cancer treatments are likely to remain a key driver, but Roche is also finding success in hemophilia, multiple sclerosis, and spinal muscular atrophy. Roche also has a promising weight-loss candidate that came with its USD 2.7 billion acquisition of Carmot.

Looking beyond a potential fall in earnings for 2024, Andersen thinks Roche is poised to generate mid-single-digit top and bottom-line growth over the next few years on a constant currency basis. Although it is worth mentioning that a strong Swiss Franc has been a headwind for some time. Andersen expects just under 6% sales growth per year in pharmaceuticals and around 4% growth per year in diagnostics through to 2028. She thinks Roche shares are worth CHF 379 each, compared to a price of around CHF 252 today.

Bristol-Myers Squibb ★★★★★

Moat Rating: Wide
Fair Value Estimate: USD 63
Share Price 24/6/24: USD 41.93

Bristol shares have suffered from concerns over patent losses and worries over the debt load it took on to buy Celgene for USD 74 billion in 2019.

Morningstar’s Bristol analyst Damien Conover assigns the firm a Wide Moat rating based on its broad lineup of patent-protected drugs, an entrenched sales force and economies of scale. In regard to concerns over Bristol’s debt load, Conover thinks the balance sheet is sound and that the amount of debt is manageable once Bristol’s debt maturity schedule and low business cyclical are considered.

Bristol is aggressively repositioning itself to expand through challenging patent losses. The company has shed its diabetes business, medical imaging group, wound care division, and nutritional business to focus on the high-margin specialty drug group. The Celgene acquisition moves Bristol significantly further into the specialty pharmaceutical segment of the market.

Bristol's two top drugs – cancer treatment Opdivo and cardiovascular drug Eliquis – see their patents expire in 2027-28. Conover thinks the firm is developing a strong pipeline to mitigate the upcoming patent losses. In his opinion, Bristol’s focus on immunology, oncology, and rare diseases should increase the probability of development success, given the higher level of unmet medical need in these areas.

Conover assigns Bristol a fair value of USD 63 per share. He expects Opdivo and Eliquis to grow healthily before the patent losses begin and thinks that Bristol remains well positioned in treatments for melanoma and renal cancer. The current share price of around USD 42 represents a 34% discount to his estimate of Fair Value.

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All prices and analysis at 26 June 2024.  This information has been prepared by Morningstar Australasia Pty Limited (“Morningstar”) ABN: 95 090 665 544 AFSL: 240 892.

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