BIG Monkeys & a Looming Intervention: Pharma’s US Pricing Addiction

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Richard Evans / Scott Hinds / Ryan Baum

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@SSRHealth

May 9, 2014

BIG Monkeys & a Looming Intervention: Pharma’s US Pricing Addiction

  • Please see the SSR Health YouTube channel for podcasts of recent research
  • US real pricing gains for drugs sold in the US are driving nearly all of the traditional large cap pharmaceuticals industry’s growth. Only Roche and JNJ have US sales growth that exceeds the rate of US price growth, i.e. every other company gets more than 100% of its US (and in many cases global) growth from US pricing gains
  • Obviously if US pricing power weakens, these companies cannot sustain anything approaching their current growth rates (or in many cases current rates of decline would sharply increase)
  • We believe co-pay cards are a serious and generally under-appreciated risk to US pricing power. Because manufacturers appear willing to keep patients’ out-of-pocket costs at manageable levels with co-pay subsidies, payors are likely to begin raising patients’ out-of-pocket Rx costs under the very reasonable expectation that manufacturers will respond by offering more generous co-pay subsidies. The extension of more generous co-pay subsidies (as are currently being provided to health insurance exchange beneficiaries) to the far larger population of employer sponsored beneficiaries has the potential to very nearly eliminate US real pricing gains. The only question is whether this will happen, and if so when (pls see our May 8, 2014 note for details)
  • Some companies clearly are more susceptible than others. Rapid and/or accelerating rates of price growth that account for very large percentages of US sales gains, pending major patent losses, high relative valuations, relative lack of cost offsets, and high dividend to gross profit ratios are key indicators of risk
  • We believe ABBV, LLY, NVO, and SNY are most susceptible to secular declines in US real pricing power, followed to a lesser degree by MRK
  • No companies are immune to the risks, though BAYR.Y, CELG, GILD, JNJ and Roche appear least at risk
  • N.B.: This note deals narrowly with companies’ ability to increase the price of a constant basket of goods over time, i.e. we’re not addressing the (also important) ability of companies to bring new products to market at higher and higher prices (e.g. Sovaldi), though we will address this in a later note. We believe companies’ ability to raise price on a constant basket of goods is very much at risk in the near- to mid-term; conversely we believe companies’ ability to launch innovations at current high prices is relatively secure in the near- to mid-term

With only two exceptions (Roche, JNJ), more than 100 percent of the traditional large cap pharmaceutical companies’ US brand sales growth (grey bars, Exhibit 1) is driven by US pricing growth (green bars). Where these companies are growing, they are growing only because prices for products sold in the US are rising. Only in the biotech space do we see relatively large companies (e.g. BIIB, GILD, CELG) whose US brand sales growth (grey bars, Exhibit 2) is driven by factors other than pricing gains (green bars)

If US real pricing gains are the only source of growth (or means of slowing declines) for most (particularly traditional) companies, then it’s obvious that loss of US pricing power would all but eliminate growth among the traditional companies; and, that the companies whose sales are already declining would simply decline more rapidly

We believe US pricing gains face significant near- to mid-term risks. Specifically, we believe that widespread availability of generous co-pay card programs allows plan sponsors and formulary managers to raise the percentage of drug costs that patients must pay out-of-pocket. In effect, payors have reason to be confident that manufacturers will use co-pay card programs to keep patients’ actual out-of-pocket costs at affordable levels as the patient’s share of costs rises. Because the subsidies manufacturers pay via co-pay cards reduce net pricing, if co-pay card programs offer larger subsidies to more patients, the industry’s net pricing power falls. Details on the interplay between co-pay cards and drug pricing, and the manner in which use of co-pay cards by health insurance exchange (HIE) beneficiaries serves to prove manufacturers’ willingness to provide more generous subsidies, can be found in our recent reports[1]

Our immediate aim with this research note is to highlight the degree to which various companies are reliant on US drug pricing, and by extension which companies are more or less susceptible to any loss of US pricing power. This note narrowly addresses companies’ reliance on an ability to raise the prices of existing products over time. Companies’ ability to claim ever larger launch prices for new products – an important component of US pricing power highlighted by the ongoing Sovaldi controversy – is something we’ll reserve for an upcoming note

On the subsequent pages, we provide two graphics for each company analyzed. The first is a sales-weighted index of each company’s real branded pricing over the past several years. With the exception of VRTX (whose price series begins in 2011) each company’s price index begins at a starting value of 100 in December of 2006. The y-axis of each exhibit denotes the index value; all y-axes across all companies are to the same scale to allow easier comparisons. The x-axis of each exhibit runs from January thru December. This way the line graph of pricing index values for each year are laid on top of one another, which makes it far easier to get a visual sense of whether (and when) the company has accelerated its US real brand pricing, and of whether the company has begun to take more increases each year than it has in the past. In Exhibit 3, we show SNY’s pricing index as an example. It’s clear that SNY began to accelerate US brand pricing at the end of 2011, and has since continued to accelerate by taking multiple large pricing actions within any subsequent 12 month period. By comparing SNY’s index to others, it’s clear SNY is pressing US price far more aggressively than its peers

The second graphic provided for each company is a star-chart of five values that help determine the relative extent to which a given company may be reliant on US real pricing gains. All star-chart values are relative, and in all cases smaller values are more desirable than larger values. Green lines indicate each company’s score on each of the metrics, and the black line at value 1.0 around the star chart indicates the peer average. Companies with most values outside the black lines are more susceptible to changes in real US pricing power, and vice versa

The first variable at the 12:00 position on each chart is the product of growth in US pricing, and the percentage of global sales that comes from US brands. Obviously companies with greater shares of global sales in the US and faster US rates of US pricing will be more reliant on US pricing than companies with less sales in the US and less rapid rates of US pricing growth

The second variable at the 2:00 position is ‘LOE exposure’, and is defined as the percent of current sales subject to loss of exclusivity within the next three years. The premise here is that companies that are losing larger percentages of sales to LOE in the near term are more reliant on US pricing power as a means of offsetting those LOE effects

The third variable at the 5:00 position is ‘Div / gross π’, and is defined as the ratio of dividends to gross profits. The logic here is that because US pricing has such an outsized effect on gross profit, companies whose dividends are large relative to their gross profits are more likely to have to cut dividends if pricing power is lost

The fourth variable at the 7:00 position is ‘R&D offsets’, and is simply one minus R&D as a percent of sales. The simple logic here is that a large portion of R&D spending is relatively discretionary in the short term, and can be reeled in quickly as an offset to margin pressures in the event of lost US pricing power

The fifth variable at the 10:00 position is ‘fPE ‘16’, and is simply the company’s relative forward price : earnings ratio on 2016 consensus. The simple logic here is that a heavily price reliant stock with a higher fPE is likely to have a larger percentage drop in share price than a similarly price reliant stock with a smaller fPE

LLY and Roche serve as examples in Exhibits 4a and 4b, respectively. LLY has a large percentage of total sales from US brands and is raising US prices rapidly, and thus is highly reliant on US pricing for current revenue growth (‘US pricing × US/WW revs’, at 12:00). Conversely, Roche has a smaller percentage of total sales from US brands and is raising US prices relatively slowly, and so scores much lower (better, as in less susceptible to loss of US pricing power) on this same metric. LLY has more upcoming patent losses (as a percent of current sales) than peers; Roche has substantially less (‘LOE exposure’, at 2:00). LLY’s dividends are smaller relative to its current gross profits than are Roche’s (‘Div / gross π’, at 5:00), though we’re unconcerned about Roche’s dividend to gross profits relationship because it relies so little on US pricing. LLY spends more on R&D as a percent of sales than peers, and by a greater margin than Roche, so both score below (better[2] than) par on ‘R&D offsets’ at the 7:00 position. Finally, both companies have forward price : earnings ratios on 2016 consensus that are near par with the peer group (‘fPE (’16) at the 10:00 position)

Exhibit 5 summarizes these 5 relative values across all of the companies, and somewhat simplistically ranks the companies from lowest (least susceptible) to highest average score. Our sense is that some of these variables matter more than others, i.e. that the simple average of the 5 variables shouldn’t be the focal point. Instead, we believe that companies that are raising price quickly, are accelerating, and are apparently very reliant on those increases, have the most lose if US pricing power fades. We believe ABBV, LLY, NVO, and SNY are most at risk. Exhibit 5 is immediately below, and company-specific exhibits begin on the following page

  1. “Co-Pay Cards & the Stalling of Drug Rebate Growth Part II – The HIE ‘Test Case’”, SSR Health LLC, May 8, 2014; and “Co-Pay Cards: A Bottle for the Drug Pricing Genie”, SSR Health LLC, August 7, 2012. These and other archived notes can be found at www.SSRHealth.com
  2. Any argument we’re making that high R&D / sales is a good thing is meant only in the context of companies’ ability to find quick savings to offset loss of US pricing power. The complete story about how we view R&D spending relies heavily on whether or not the company’s R&D spending is productive, either relative to peers or in absolute terms. Neither company offers an attractive level of R&D productivity, and LLY’s productivity is particularly weak. See www.hiddenpipeline.com
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