Pharma innovation has rebounded post-COVID

Fitch Ratings-London-20 December 2022: The global pharmaceutical and biotech sector is returning to innovation-driven growth as demand normalises following Covid-related dislocations, Fitch Ratings says. However, new treatments will increasingly be subject to regulatory attention, particularly regarding access and drug pricing. Meanwhile, favourable secular trends will also support industry growth. We expect business models in the industry to continue to specialise around three core pillars: innovative pharma, generics and consumer health. This follows the simplification of business models established by Pfizer and GSK that focused on core innovation. We expect a similar strategic refocus could be implemented at Novartis, which has already expressed its desire to separate its generic and innovative pharma businesses, and streamline its research efforts. We also expect Sanofi to continue its repositioning towards specialty pharma over the medium term. The specialisation of business models reflects increasingly diverging underlying strategic drivers. Generics and consumer health are benefitting from increasing scale and access to distribution, whereas the specialisation of innovative pharma reflects the strong innovation pipeline increasing capital requirements to support state-of-the-art research. We also expect active portfolio management within companies’ divisions, including targeted M&A and partnering opportunities, but also divestments of tail-end drugs and brands to free up resources for innovation. In our view this will continue to offer significant investment opportunities in the mid-cap pharma market, attracting significant private equity capital, particularly in consolidating European markets. Research and development productivity is becoming increasingly important as complexities and investment requirements of new drug developments are growing. Given a rising risk/return ratio, we expect market participants to take a more targeted and selective approach to bolstering research, favouring partnerships and cooperation over outright M&A, and business models that have been successfully implemented during the pandemic. However, we also expect regulators to increasingly focus on access to treatment and pricing, particularly due to public finances being under pressure after the pandemic. Most Fitch-rated global pharma companies enter 2023 with comfortable rating headroom. This not only reflects benefits for issuers involved in the pandemic response (including treatments and vaccines), but also the business model specialisation, which has led to a simplification of businesses, often raising disposal proceeds and increasing financial flexibility. However, the current rating headroom could be reinvested in the business, particularly to strengthen innovation or scale selectively, like the recently announced acquisition of Horizon by Amgen. We expect total debt/EBITDA across the sector to gradually trend back towards 2x by 2024, which we view as the historical average. We also expect cash flow generation in the sector to remain stable. As we project a steady and favourable operating environment for global pharma issuers over our rating horizon, rating changes are likely to be driven by capital allocation decisions. In addition, the current capital market environment might make access to capital for early-stage biotech ventures more difficult, offering consolidation opportunities. In the absence of investments into the businesses, we would also consider there to be some event risk around an increase of shareholder distributions.