S&P expects steady erosion in Big Pharma's credit profile in 2021 as new M&A deals roll in — but don't underestimate their underlying strength
S&P Global has taken a look at the dominant forces shaping the pharma market and come to the conclusion that there will be more downgrades than upgrades in 2021 — the 8th straight year of steady decline.
But it’s not all bad news. Some things are looking up, and there’s still plenty of money to be made in an industry that enjoys a 30% to 40% profit margin, once you factor in steep R&D expenses.
What’s driving the downgrades?
First, added debt to pursue new M&A, which S&P expects will continue to be a regular part of the news for the rest of the year. In part, that’s because biotech companies still see the need for a Big Pharma player when it comes to their global market reach. And then there are all the same, persistent factors that push pharma to the buyout table.
Many industry participants are eager to invest in the very attractive, rapidly expanding, and highly profitable therapeutic areas of oncology and autoimmune diseases on the heels of meaningful advancements in medical knowledge and pharmaceutical technologies. Moreover, most Big Pharma companies view M&A as an essential element of their long-term drug development strategy alongside internal R&D efforts (which average about 20% of revenues). In addition, some companies have potential patent expirations or gaps in their development pipelines of new drugs that could lead to periods of stagnant or declining revenues over the medium term. We expect those companies to be particularly eager to address this by acquiring drugs with high growth potential.
S&P then turns to divestitures, which is reducing profits, like the big Pfizer move to merge Upjohn and Mylan into Viatris. In Pfizer’s case, S&P expects CEO Albert Bourla to spend much of the money they gained on new products for the pipeline. That doesn’t translate into immediate new profits, though, and divestitures add to the pressure to boost dividends, also hamstringing companies when they may need the flexibility to spend more on the business.
Then there’s the pricing issue — both from pricing constraint as well as the added shot at pricing reform with a new Biden administration.
PBMs continue to exert their market leverage to weigh in on prices, which S&P expects to continue. New moves to integrate on the PBM side of the business are also adding to their ability to keep prices down.
Although this constraint has been in place the last few years, we expect it to persist this year and net branded pharma prices to be relatively flat, possibly nominally negative.
Then there’s pricing reform after the Dems gained control of the Senate and the White House.
As the Democratic Party controls both the executive and legislative branches, and amid bipartisan support for reducing prescription drug spending in the U.S., we believe it’s more likely some combination of proposals could advance in 2021 and be a moderate drag on profit margins. We also believe federal and state budgetary pressures following the pandemic and related economic stimulus packages could escalate this.
None of this, though, presents game-changing threats to the pharma model. And S&P is also careful to list all the strengths that Big Pharma can continue to rely on in 2021. That list includes:
— An end to rapid price erosion on the generic side.
— The looming end to opioid litigation.
— An improved rep with the public following the Covid-19 campaign, which may blunt pricing reform.
— Risk sharing gets a big thumbs-up. “Big Pharma is increasingly utilizing partnerships, royalties, and milestone-based agreements in place of outright acquisitions to mitigate the development and regulatory risks. We view these as less negative for creditworthiness than outright M&A.”
— New product launches should outweigh generic competition.
— And the growth of digital marketing should play out with lower costs.
Add it all up and pharma is looking at another year of ups and downs.