Pharma: research is worthy of value seekers’ research

Big Pharma’s agile response to Covid-19 was impressive. But hopes that drug developers could sustain some of those productivity gains are subsiding. Research and development returns have reverted to their pre-pandemic declining trend.

A Deloitte report on drug development at the 20 biggest pharma companies found its average cost, which dipped in 2021, rose by 15 per cent to $2.3bn last year. Meanwhile, average peak annual sales forecasts dropped by a fifth to $389mn, reflecting the fading contribution from Covid jabs and drugs.

The rate of return on large pharma companies’ R&D averaged 10 per cent in the six years to 2022, estimates Berenberg, not far above their cost of capital of about 8 per cent. Some, such as France’s Sanofi, undershot. At the other end of the scale, Denmark’s Novo Nordisk notched up returns of more than 20 per cent.

Such calculations are tricky. Drugs can take a long time to generate profits. The origins of Merck’s Keytruda dates back 20 years; it was nearly dropped in 2009. The cancer treatment should be this year’s top-selling drug with sales of $24bn, according to Evaluate Vantage.

Companies can raise their game. Over the past year AstraZeneca moved from laggard to leader in the R&D productivity ranking with a focused approach. But hurdles are high. Oncology accounts for 36 per cent of Big Pharma’s pipeline assets. Companies compete in a crowded field. Costs are high partly because cancer clinical trials take 30-40 per cent longer than for other drugs.

US drug pricing reforms could squeeze returns. Eli Lilly last year scrapped development of a drug targeting blood cancers. Bristol Myers Squibb has warned of similar moves.

Investors value future drugs according to their chances of success and potential market size. But future cash flows are discounted, so the pipeline typically accounts for just 15 per cent of a company’s net present value.

Companies that have ingenious and efficient R&D operations deserve a premium. As patents expire, pharmaceutical companies’ ability to renew themselves is vital.