Morningstar Magazine - August/September 2017 - 68

Investors

project immuno-oncology sales to represent
about 20% of their overall sales, so they are
not as focused as Bristol. And Merck has a patent
exposure that we think somewhat offsets the
potential in immuno-oncology.
We also looked at Pfizer PFE, which has partnered
with Merck KGaA MKGAY (German Merck),
and AstraZeneca AZN. They have certain strategic
positioning that should enable them to do
well in certain types of cancer, but it's hard for
us to see them getting a dominant slice of
the overall market.

within that class, and we also think Pfizer is
undervalued. A big piece of that is due to the
strength that we think Ibrance, their CDK 4/6, will
have in the market.
The other waves of improvement we're seeing are
in immunology, in areas like psoriasis,
rheumatoid arthritis, Crohn's disease, ulcerative
colitis. There are major advancements there.
Within the next five to 10 years, neurology probably
will be the next wave, but the science needs
to get a little bit further along before we see major
advancements there.

When we think about the next generation
of products, immuno-oncology drugs are
very transformative.

Conover: Immuno-oncology drugs are going to
displace mostly older chemotherapy drugs mostly
sold by generic firms. The margins aren't very
high, so it shouldn't be overly detrimental, but the
generic market might have a little bit of a setback
there. There are some branded products that
will likely feel some pressure, and Roche has some
of those drugs. It's likely some of them will
still be used in combination, but there also would
likely be some displacement there.

In one of your reports earlier this year,2 you noted
that HIV drugs and multiple sclerosis drugs enjoy
significant pricing power.

Outside of immuno-oncology, what are other significant
opportunities for Big Pharma and biotech right now?

Conover: The strongest pricing power tends
to be in oncology and immunology, but there are
other areas that also have reasonable strength
of pricing power, and a couple of those are multiple
sclerosis and HIV. With multiple sclerosis,
there's a fair bit of complexity of treatment, and that
complexity, both in sequencing drugs and tailoring
drugs to individuals, has made the drugs less
interchangeable. In the HIV landscape, there is a
lot of concern about sequencing as well, because
doctors want to avoid any sort of viral resistance,
and that also enables some stronger pricing power.

Conover: There's other innovation within oncology.
We're seeing major innovation within the CDK 4/6
class of drugs, a new wave of drugs for
breast cancer. We think Pfizer is best positioned

Diabetes drugs, on the other hand, is an area
where we've seen a lot of pricing pressure.
Insulins are very interchangeable. Companies are

2 Andersen, K. and Conover, D. 2017. "Healthcare Observer." February.

Morningstar August/September 2017

Are there policy changes on the horizon that might
affect pharmaceutical pricing power?

Conover: Within the healthcare reform that is
being discussed in Washington, there are not a lot
of changes to drug regulations. A lot of those
reforms have to do more with insurance and
hospitals. The most probable near-term reform that
could impact the drug industry involves dualeligible patients-patients who are eligible both
for Medicare and Medicaid. If there is a change so
that they are reimbursed under Medicaid pricing
instead of Medicare, that would be significant
because Medicare drug prices can be close to 30%
higher than Medicaid. That would probably
hurt large biotech and large pharmaceutical firms'
earnings by close to 5% in aggregate, so that
could be a major hit. But we think there is less
than a 50% likelihood of that happening.
How would you classify the prospects for the
industry overall?

Damien Conover

Are there any companies you cover that are directly
threatened by immuno-oncology?

being pressured by the large payers to lower
their price. This will probably spread to some of the
oral diabetes medicines as well.

Conover: We're anticipating large-cap
pharmaceutical firms growing close to 5% annually
over the next five years. That growth, combined
with an average dividend yield of close to
3.5% to 4%, gives you a reasonable return with the
likelihood of a little bit of capital appreciation,
as we see the large-cap pharmaceutical stocks as
modestly undervalued. They aren't steeply
undervalued, but we like these firms, especially
relative to the valuations outside of healthcare,
because in aggregate, Morningstar considers the
market to be slightly overvalued. K
Laura Lallos is the managing editor of Morningstar magazine.

Table of Contents for the Digital Edition of Morningstar Magazine - August/September 2017