May 18, 2010 / 12:43 PM / 9 years ago

ANALYSIS - EU austerity drive a bitter pill for drugmakers

LONDON (Reuters) - Drug prices are in the firing line as European governments tackle runaway budget deficits, leaving investors with a dilemma about how to view the sector.

Defensive industries like pharmaceuticals, with strong cash flows and healthy dividend yields, should be something of a bolt-hole from the euro zone debt crisis.

Yet some drugmakers — notably mid-sized firms heavily exposed to western Europe — could take a profit hit of around 10 percent as a result of the new round of price reductions, although the impact on big multinationals will be a lot less.

Analysts pick Germany’s Bayer and Merck KGaA, Spanish group Almirall and Belgian UCB as companies most at risk, while among the majors, Novartis has one of the highest exposures to the cuts.

Greece has launched the most brutal cuts, slashing the price of medicines by 21.5 percent on average, while Germany has set out far-reaching plans that amount to an effective price cut of some 10 percent.

Last week, Spain announced a further wide range of price cuts for patented drugs from Aug. 1 and industry watchers say new cutbacks are likely to come soon from Portugal and Italy.

“The drugs budget is very easy to identify and drug companies are very profitable, so it is an easy target for governments,” said Mark Clark, an analyst at Deutsche Bank.

“Although drug stocks have held up relatively okay through the latest malaise in the markets, we certainly haven’t seen a huge amount of buying enthusiasm ... this adds to the bubbling cauldron of reasons not to invest.”


The planned cuts in major markets like Germany and Spain will strengthen the hand of payers in France, Britain and other countries, where governments are preparing austerity programmes.

The spillover effect of price cuts from one country to another is amplified in Europe because of so-called reference pricing and parallel trade.

“If you get large cuts in one country, it is going to have a large knock-on effect in countries that use those prices as a reference,” said Colin Mackay, a spokesman for the European Federation of Pharmaceutical Industries and Associations.

“It hasn’t happened yet, because these things take time to pan out, but it is a major worry.”

Reference pricing is common throughout the Europe Union and even beyond, with countries including Japan and Canada also taking account of European prices when deciding reimbursement.

At the same time, European wholesalers are allowed to “parallel trade” drugs by buying them in low-price markets and reselling in high-price ones — effectively exporting price cuts — although drugmakers have started to limit this practice by setting allocations for individual markets.

Keeping track of the changing reimbursement landscape across multiple markets is becoming “like a game of whack-a-mole”, according to analysts at Leerink Swann.

Overall, Morgan Stanley estimates European drugmakers face a hit of around 3 percent to 2011 earnings per share from price controls announced to date, and this could rise to 8 percent in a “very unlikely” worst-case scenario.

Citigroup, meanwhile, estimates that if there were coordinated cuts across Europe’s top five markets, resulting in price reductions of 5-10 percent, this would lop 3 to 6 percent off sector EPS.


The impact, however, will not be felt equally, with smaller European-based companies much more exposed than larger rivals.

Morgan Stanley estimates the impact on drug profits at Bayer and Merck KGaA could be 11 percent, against just 2-4 percent for multinational drugmakers overall.

Citi sees downside EPS risk of 17-34 percent for Almirall, 9-18 percent for UCB, 5-11 percent for Merck and 4-7 percent for Denmark’s Novo Nordisk.

Among the bigger companies, Novartis, with 35 percent of sales in the EU, has relatively high exposure to European cuts, while GlaxoSmithKline and Roche are among the lowest.

Until recently, global pharmaceutical investors have focused more on pressure in the United States, where President Barack Obama’s health reform is driving down prices in the short term.

By contrast, the changes in Europe, where the state pays a bigger role in healthcare spending, are harder for investors to track — but the continent still accounts for 31 percent of global drug sales, against 39 percent for North America.

(Editing by Sitaraman Shankar)

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