Navigating the drug pricing debate

03/08/2018

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​When the Trump administration introduced a ‘blueprint’ to lower drug prices in May, the pharmaceutical industry breathed a sigh of relief. Andy Acker and Ethan Lovell, Portfolio Managers of the Global Life Sciences strategy, discuss.

 

When the Trump administration introduced a ‘blueprint’ to lower drug prices in May, the pharmaceutical industry breathed a sigh of relief. The proposal excluded recommendations such as allowing the government to negotiate drug prices directly with manufacturers or importing lower-cost prescription drugs from abroad, each of which could have caused significant disruption.

But the reprieve did not last long. In late June, Amazon.com announced it was buying PillPack, a mail-order pharmacy licenced to ship prescriptions in 49 states. Less than two weeks later, Pfizer raised prices on dozens of drugs – only to backtrack and postpone the hikes after President Trump criticised the move in a sharply worded tweet. Since then, other companies have also delayed price increases or even lowered prices.

In short, scrutiny over drug pricing continues, with the potential to intensify as we approach the US midterm elections. However, we think any potential reforms could take years to implement, and the impact for most companies should be moderate. Meanwhile, innovation within the sector remains high, leading to transformational therapies. With that in mind, we believe investors should be mindful of these key trends going forward.

Improving multiples

Given the uncertainty around drug pricing, biotechnology and pharmaceutical stocks have lagged the MSCI World Health Care Index, falling 1.0% and 2.2% respectively during the first half of 2018, while the benchmark gained 1.9%. However, we believe the underperformance has helped make valuations within these categories more attractive, especially in light of continued innovation.

Indeed, in April, late-stage clinical trial data showed that one lead immuno-oncology drug, in combination with chemotherapy, cut the risk of death for patients with advanced non-small cell lung cancer by 51%. We feel this represents a revolutionary advance for the leading cause of cancer death in the world. It also demonstrates both the clinical and commercial potential of these drugs, which harness the body’s immune system to attack and kill cancer cells. Immuno-oncology agents reached US$10 billion in sales in 2017, and we expect the number could exceed US$15 billion this year, with the potential to go much higher in the future.

A focus on value

The market could start to appreciate this innovation as the focus on value within the healthcare system intensifies. Last month, the US Food and Drug Administration (FDA) released guidance about how manufacturers can appropriately communicate a drug’s efficacy when negotiating so-called value-based contracts with payers. These contracts aim to tie reimbursement decisions to the overall treatments, an approach that is gaining ground in the US and select other countries. As Scott Gottleib, FDA commissioner, said in an adjoining statement: “Prices should be able to adjust to reflect the value in how medicines are prescribed and the outcomes they deliver, to control rising spending and reduce the burden of drug costs for consumers.” Companies whose therapies improve upon the current standard of care may have wider latitude to price attractively and secure reimbursement. For others, the stakes are rising.

Supply chain pressures

Members of the drug supply chain – distributors, pharmacy benefit managers and pharmacies – may also start to feel pricing pressure. Rebates and discounts paid by drug makers to the supply chain are often pointed to as one reason for rising drug prices. The discounts are calculated as a percentage of a drug’s list price, so the higher the price, the fatter the payout.

Trump’s blueprint proposes changing the incentive structure for rebates, including passing on some of the financial benefit directly to consumers. If regulators fail to make an impact, Amazon could eventually achieve a similar goal with its entry into drug distribution. As Amazon’s CEO, Jeff Bezos, famously quipped, “Your margin is my opportunity”. Either way, we expect that the supply chain could get squeezed. The market seems to agree: for the first half of the year healthcare distributors, as a sub-sector, declined by almost 10%.

The recent divergence in performance between innovators and the drug supply chain could continue in healthcare, underscoring why we think it is critical for investors to focus on fundamentals and understand the nuances when approaching the sector.

 

These are the views of the individuals at the time of writing and may differ from the views of other individuals/teams at Janus Henderson Investors. Any sectors, indices and securities mentioned within this article do not constitute or form any part of any offer or solicitation to buy or sell them.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

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Janus Henderson Global Life Sciences Fund

Key investment risks to be considered before investing.

  • The Fund may invest in any one or a combination of the following instruments:
    • futures, options and swaps and other financial derivative instruments (“FDI”) for investment purposes, up to 10% of the net asset value ("NAV") of the Fund. Given the leverage effect of FDI, such investments may result in substantial loss (as much as 100% of the NAV of the relevant Fund);
    • debt securities rated below investment grade; and
    • mortgage and asset-backed securities and/or in index/structured securities. These financial instruments may be rated below investment grade.
  • Investing in any one of the above instruments may involve substantial credit/counterparty, market, liquidity, currency, leverage, index, interest and swap risks. If the issuers default, or such securities or their underlying assets, cannot be realised or perform badly, investors’ entire investments may be lost.
  • The Fund's investments involve developing markets. Owing to its potentially higher volatility and risk levels, as well as lower political and economic stability than developed markets, asset values could be affected in various levels.
  • The Fund’s investments may be more concentrated in terms of industry risk than others that diversify across industries and may therefore be subject to higher industry risk than funds with more diversified holdings.
  • The investment decision is yours. If you are in any doubt about the contents of this document, you should seek independent professional financial advice.
  • Investors should not only base on this document alone to make investment decisions and should read the Prospectus including the risk factors for further details.

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