Negative outlook for global pharmaceutical industry

The outlook for the global pharmaceutical industry is negative, reflecting the increasing exposure to patent expiries and downward trends in pipeline quality, Moody's Investors Service said in a new report.
"Unlike that of most other industries with negative sector outlooks, Moody's view on pharmaceutical companies is not predominantly tied to the broader economic climate; rather, it is based on industry-specific factors," said Marie Fischer-Sabatie, senior analyst in Moody's Corporate Finance Group. Although operating profits and cash flows are likely to show further improvement in the next 12 to 18 months, two critical performance indicators Moody's uses in assessing pharmaceutical companies have weakened and are likely to weaken further in the short to medium term: (i) the percentage of pipeline peak sales to total revenues, and (ii) the percentage of patent expirations to total revenues. Moody's expects these negative pressures to remain a key feature of the industry until the 2010-12 patent cliff is largely over.
To alleviate these pressures, pharmaceutical companies have been active in M&A, which reached an unprecedented level in 2009. Moody's expects such consolidation and diversification to continue in the short term, but to a lesser extent than in the past 12 months and more oriented towards small- to mid-sized transactions of a bolt-on nature. "Although such bolt-on deals are not expected to lead to rating downgrades to the same extent as those following recent mega-mergers, they could still exert downward pressure on the ratings of companies that do not have much leeway in their rating category," explained Fischer-Sabatie.
"Furthermore, they could also contribute to a further increase in balance sheet leverage in the industry, albeit from a low level compared to other industries," she said.
The negative outlook also reflects uncertainty over US healthcare reform, which could be enacted by year-end and which could potentially have negative implications for the industry worldwide. "However, at present, we do not believe such reform will present onerous burdens for the pharmaceutical industry," said Michael Levesque, a Senior Vice President in Moody's Corporate Finance Group.
Moody's recognises that swine flu vaccines will provide a boost to 2009 earnings for some companies. However, future revenue and earning from pandemic flu vaccines are unpredictable and not part of Moody's base forecasts; thus, they are viewed as a potential upside to Moody's projections for those companies having operations related to flu treatments or vaccines.
Moody's maintains a more positive sentiment about the outlook for generics-focused pharmaceutical companies. Generic drug companies will benefit from a large number of blockbuster drugs going generic in the coming years as patents expire as well as from the increasing proportion of drugs that are dispensed generically in many markets. Although the generics drug industry still presents certain credit risks, stemming from intense competition and pricing erosion due to relatively low barriers to entry, Moody's expects that new product launches will more than offset this pressure for the next several years.
Moody's currently rates 35 pharmaceutical companies, four of which are generics companies.