Citi reveals the 'killer apps' that will unlock value in pharma sector

Threatened by patent expiries and dwindling healthcare budgets, the pharmaceuticals industry has long been portrayed as being in terminal decline.

However reports of its demise would appear to have been greatly exaggerated if the latest research from the Wall Street bank Citigroup is anything to go by.

Analyst Andrew Baum paints a guardedly optimistic picture of a sector in recovery, and picks out GlaxoSmithKline (LON:GSK) as his top UK pick.

In a 104-page tome he says the key to unlocking value in this fast evolving market is the deployment of three ‘killer apps’ -  he calls the apps shrink, smarten and spin.

Far from being applications that run on a smartphone or tablet, the apps reflect more a mindset that should be adopted by Big Pharma.

Shrink is an obvious one and refers to the process already ongoing in the drugs sector where formally fat, unresponsive multi-nationals have slimmed down to become fleeter of foot.

However Baum and his team still see 25-30 per cent overcapacity in fixed research costs that can be reduced to improve earnings per share.

Smarten, Baum says, means improving the time it takes to identify and bring through the next generation of medicines.

The industry is adopting a model called fast to fail, which the analyst applauds.

Fast to fail means if you are developing a drug you want it to fail early in the process rather than persevering with it through the later, hugely expensive stages of clinical trials.

The money saved – and it can run into hundreds of millions of pounds – can then be spent on the more promising candidates.

“Widespread adoption of new ‘fast-to-fail’ models across the industry promises to significantly reduce cycle times and the associated costs of drug  development,” Baum said.

“Investors should see a significant improvement in R&D productivity as a consequence.”

Spin is all about spinning out the pipeline, or in layman’s terms, finding a partner to share the financial risk that comes with bringing new blockbusters to the market.

While this happens in the pharmaceuticals industry, the practice is rare.

“Externalisation and the use of alternative financing has many potential positives,  enabling companies to access both capacity and external financing to increase the  value of their compounds,” explained Baum.

“Direct operational benefits include faster decision making, improved portfolio management, and greater returns on R&D investment.

“Concurrently, we believe that externalization can help to crystallize the value of  companies’ historic and ongoing research investment in share prices.”

The research highlights Glaxo, which is rated a ‘buy’ with a £15.70 price target, as having these killer apps. Citi's two other favourite European stocks are Bayer and Sanofi.

Shire (LON:SHP) is also rated ‘buy’, with a price target of £24, while AstraZeneca (LON:AZN) is worth £28 a share and carries and ‘neutral’ recommendation. AZ’s “lack of businesses development” worries Citi’s drugs guru.