Pharma sector set to outperform this year

The pharmaceuticals sector will continue to outperform this year after a stellar 2011, according to research from Berenberg Bank.

Its safe haven status attracted investors during last year’s economic and market turmoil.

This has one downside, according to analyst Alistair Campbell.

“This does leave the sector vulnerable to rotation, as has been seen so far this year. However, we believe some fundamental progress within the sector must be taken into account,” he added.

However, he points out that the sector, despite last year’s revival, is still trading on a relatively undemanding price-to-earnings multiple of 10.8 times, which suggests there is plenty more growth potential.

“Fundamentals of the sector have unequivocally changed for the better,” Campbell explained.

“We believe the pharmaceuticals sector remains attractive even after 12 months of relative outperformance and revisit three main points to support our sector view.”

The industry in the past few years has been hit by a phenomenon called the patent expiry cliff, where many of the top selling drugs have lost their patent protection, opening them to copycat competition.

This has then had a knock-on effect on earnings. The trough is profits is expected this year, and in the meantime the companies are slowly restocking their medicine chests.

America’s regulator the Food & Drug Administration is expected to approve 35 new drugs this year, the highest number since 1995.

Pfizer (NYSE:PFE), GlaxoSmithKline (LON:GSK) and AstraZeneca (LON:AZ) are examples of companies where the patent expiry cliff has hit home hard. For AZ this has led to several rounds of cost-cutting and job losses.

GSK, meanwhile, was hit by the problem earlier than many of its rivals and has taken some innovative steps to refill the product pipeline.

Berenberg this morning upgraded Europe’s largest drugs company to ‘buy’ from ‘hold’ and reckons the shares are worth £16.40 each (current price £14.07).

“GSK turned the corner in terms of earnings last year and should deliver mid single-digit growth this year,” said Campbell.

“More importantly, we feel GSK is definitely moving in the right direction in terms of redesigning research and development, and encouraging a more innovative culture.

“While others are following suit, GSK is further down this path than most.”

Berenberg also has ‘buy’ recommendations on Sanofi Roche and Novartis. This morning it downgraded Bayer to ‘hold’ from ‘buy’ and has ‘hold’ ratings on AZ and Novo Nordisk.