For many investors, health care is the safe option.
But John Bowler, Manager of the Schroder Global Healthcare fund argues that these investors are missing the fact that important and exciting progress in our understanding of diseases is being made. Genuine progress in areas such as cancer is triggering a new technology cycle which will drive exciting growth opportunities for the sector.
"Until 2008, the pharmaceutical sector was viewed as a value trap. Product failures and the prospect of a collapse in sales following the loss of patent exclusivity cemented the view of perpetual decline.
"Since 2008, a new cadre of management has been brought in to turn the industry around. The result has been better capital discipline and a greater focus on shareholder returns. All this at a time when income-generating stocks were a scarce commodity because of the financial crisis. The results were positive for the sector: the resiliency of these businesses and more importantly their cashflows has gradually become appreciated by the market driving a steady re-rating in the stocks.
"However, expectations for new product success remain too low. The health care sector continues to be valued by investors for its steady income in uncertain times. I think this misses an important shift that is happening in our understanding of diseases and science's ability to affect the natural course of disease.
"The number of novel drugs approved per annum by the US Food & Drug Administration has gradually risen from the mid-noughties nadir. If you look closely at what has been approved recently compared to 10 years ago we are now seeing real innovation coming through rather than a preponderance of "me-too", copycat drugs. This means exciting times ahead for the sector, and investors should take note."
Is this change real?
"2000 saw the first human genome sequenced with much fanfare that this would herald a new wave of innovation. The Nasdaq Biotech index duly peaked and subsequently collapsed as market and media expectations had greatly exceeded what science could deliver. The tools to sequence genes and analyse proteins, which are a product of genes, became cheaper, more sophisticated and importantly more mainstream. This has driven a surge in academic output particularly in more intractable diseases such as cancer.
"In the developed world cancer remains a leading cause of death, just behind heart disease. The sad truth is that despite the billions spent on research there have only been modest, incremental improvements in therapy, with one or two exceptions.
"This is potentially changing. The enhanced research tools, developed after the Human Genome project, are driving a rich vein of new targeted therapies to tackle the disease. The approach that is garnering the most excitement amongst clinicians and CEO's has been given the unassuming title of immune mediated therapy. Simply put - this is getting the body's own immune system to fight the disease.
"In principle this is not a new idea. For decades scientists have tried to develop cancer vaccines but none have proven successful.
"The difference this time is that we now have a deeper understanding of why tumour cells evade our immune system. In particular, we now know a number of the signals that tumour cells send that disarm the immune system. It is by targeting these signals that new therapies are emerging."
Imminent results could drive share prices
"While the potential positive impact of a successful new product launch is not imminent it is close enough to start to drive forecasts and share prices.
"2014 will see Bristol report the results from two phase 3 clinical studies (this is the final stage required before approval) in lung cancer. Phase 3 data for melanoma and renal cancer will report in 2015 and 2016. Roche will likely have early phase 3 data for its drug in 2015."
How big can these drugs be?
"Lung cancer and breast cancer are two of the most common cancers in terms of new patients each year. Roche's Herceptin treats 25% of breast cancer patients and has delivered over $6bn of sales in 2012. This tells us that while the potential in lung cancer alone is meaningful, if we add on the other potential tumour types the figures can become very large.
"This is not yet fully reflected in share prices and will be an important driver of shares in the near future. Bristol Myers' sales forecast for 2013 is $16bn. Adding another $6bn of sales would represent a near 40% increase not assumed by forecasts.
"For Roche the profit contribution from $6bn on incremental oncology sales would boost operating profit (2013 forecast $17.8bn) by nearly 30%. Again an increase not assumed in forecasts.
"Success should underscore that the industry has begun a new technology cycle and that it is not just small biotech companies that offer leverage to innovation. It is also the now leaner, large pharmaceutical companies that have the capital and infrastructure to rapidly exploit these innovations."
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