Pharma no antidote to stock market turmoil

AS WEAK US data continues to throw a shadow over the global recovery, investors might be drawn to adding traditional defensive stocks like pharmaceuticals to their portfolios. But contracts for difference (CFD) traders should pause before using pharma as a bearish hedge. While the big two UK firms, AstraZeneca and GlaxoSmithKline, offer attractive dividends, their prospects for growth are below par.

The major headaches for AstraZeneca and Glaxo will come from the expiry of patents on some of their major revenue-generating branded drugs. AstraZeneca relied heavily on its three flagship drugs – Crestor, Seroquel and Nexium – for $4bn of its second quarter revenues of $8.2bn this year. Seroquel’s patent is due to expire next year and Lipitor, a major rival to anti-cholesterol drug Crestor, goes off-patent next year, opening up the market to generics. Glaxo, meanwhile, relies on a wider range of drug sales but its patent on asthma drug Seretide, which brings in 24 per cent of revenues, is due to expire this year.

Even with steady sales growth in emerging markets, it will require further revenue diversification and a lot more blockbuster drug development to make up for these kinds of losses. S&P Equity Research’s Sho Matsubara cites these patent expirations as a major reason to be bearish: “They need to adjust or change their traditional business model and de-risk by diversifying. Some like AstraZeneca are still sticking to the old, pure pharma model.”

Matsubara rates Glaxo more positively, however: “It’s not relying on its top three products and can expand into vaccines, in which it is now one of the biggest producers,” he says. “And it also sells consumer health products like nutrition drinks and over-the-counter medications.”

So if you want to go long on a large-cap UK pharma firm, you are better off siding with Glaxo than AstraZeneca. And because both companies are cash-rich, they offer comparatively attractive dividend yields at 6 per cent and 5 per cent respectively. This means that those looking for a reliable income-generating stock will not be badly served by big pharma, but can still probably find better elsewhere. As for going short, this solid yield makes it overly costly for CFDs traders, who would have to pay out the dividend themselves.

More broadly, BNP Paribas Wealth Management’s Chris Alexander says that investors should consider their decision on pharmaceuticals to be a wider call on the market: “If you want to be in equities but think the market is going to fall, a safer haven within that space is UK pharmaceuticals. But if you’re looking for share price appreciation in a rising market, this sector is going to under-perform.” Of course, as Alexander points out, if you think the market is liable to fall, you are better off in bonds than in equities.

The only other way to play pharmaceuticals is to shun the sector’s defensive reputation and go for more high-risk, high-reward firms with a R&D niche. Along these lines investors could consider a long trade on Shire, a specialist manufacturer of increasingly popular attention-deficit disorder drugs. Deutsche Bank rates the firm as “buy” due to its long patent on CarrierWave, a drug delivery technology.

But even if small-cap pharmaceuticals can deliver growth, the short- and medium-term outlook for the mainstream firms is unexciting. Beyond being a solid source of income, they offer little growth or defensive benefit.