The healthcare sector has had quite a run over the past couple of years. Earnings and revenue growth have consistently been in the double digits, an especially impressive accomplishment considering the earnings recession environment. The first half of 2016 saw the S&P Health Care sector post bottom-line growth of 6% and top-line growth of 9%. The biotechnology and pharmaceutical industries have been a major driver of strength. Despite concerns that some of these names were becoming overvalued, fundamentals seemed in many cases to validate bloated price-to-earnings ratios (P/E).
For several quarters, Valeant Pharmaceuticals (VRX) was a big part of the health care growth story, putting up double-digit profit and sales growth for the 18 consecutive quarters from Q2 2011 to Q3 2015. That changed in the fall of 2015 when Democratic leaders subpoenaed the company for its drug pricing practices as Valeant came under fire for massively increasing the prices of two heart drugs.
A Deutsche Bank report in October 2015 found that price gouging was more widespread as Valeant had raised the prices of 54 drugs that year by an average of 66%. The stock dropped from $242.14 on Sept.18, 2015 to $28.93 a year later, a decrease of 88%. Valeant’s fourth quarter 2015 report showed profit growth plummeting to -3% year-over-year from the prior quarter’s increase of 30%. Results only got worse during the first half of 2016, with earnings growth falling to -46% and -48% in Q1 and Q2 2016, respectively.
Drug price gouging isn’t unique to Valeant, and has been heavily focused on during the U.S. presidential election. A tweet from presidential candidate, Hillary Clinton, chastising price gouging in the specialty drug market, sent the Nasdaq Biotechnology Index plunging 5% on Sept. 21, 2015.
Pharma companies Turing Pharmaceuticals and Mylan (MYL) have been engaged in similar practices, and, like Valeant, have suffered as a result. Turing famously hiked the price of a drug used to treat Malaria and other parasitic infections to $750 a tablet from $13.50--a 500% increase overnight. The move made CEO Martin Shkreli a household name and the industry’s newest villain. Similarly, Mylan CEO Heather Bresch came under attack for doubling the cost of EpiPens to $608 for two doses.
However, there does seem to be differentiation between how exploiters are treated versus the innovators. Much of the public outrage is specifically pointed toward price increases for generic drugs, while hikes for innovative drugs seem to get a pass. Abbvie (ABBV)hiked its arthritis drug, Humira, by 126% this year, and Teva Pharmaceuticals (TEVA) raised the price of Multiple Sclerosis drug Copaxone by 118%.
While Valeant has since eased up on its strategy of buying up lesser-known drugs and hiking prices, and cut ties with Philidor — the specialty pharmacy it was accused of engaging in fraudulent activities with — the stock is still down 72% on the year. Expect profits to continue their year-over-year declines for Q3 and Q4, with growth of -37% and -16%, respectively.
There are still some bright spots within the industry, mainly those working on cancer therapies. While Bristol-Myers Squibb’s (BMY) lung cancer drug, Opdivo, failed to prove it was better than chemotherapy in a recent trial, many are still bullish on the company. Fundamentals have been strong for the last two quarters, and there is no shortage of capital flowing into the cancer therapy space. The failed trial for BMY meant a stock surge for Merck (MRK), whose competitive drug, Keytruda, has produced more promising results, which have since led to upward revisions for earnings and revenue estimates in the second half of the year.