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EU Pharmaceuticals - Opportunities Abound

We initiate with a bullish view on the sector. EU Pharma is now trading at a discount to the market and to Consumer Staples, not seen since the ‘patent cliff years’. We show the market is discounting a worst case scenario for US pricing and that even if drug prices were to be cut by 10% in 2019, EU Pharma EPS would fall only 7%. Moreover, the industry is set to undergo a dramatic structural change with 2/3 of sales coming from Specialty Care by 2021 leading to multiple benefits. AZN & NOVN
are our top picks.

Market Discounting Worst Case US Pricing - We show the market is discounting >10% US price cuts on every single drug. Even after a 10% price cut, Pharma grows 4% CAGR 2016-21 (inc. $500m of cost savings per co.), yet trades at a 26% discount to Consumer Staples and just a 10% premium to the market. This is in-line with where the sector was trading in 2014&15 prior to the US pricing concerns arising.

Pharma to Benefit from Structural Shift - We show that 2/3 of Pharma sales will come from Specialty Care drugs by 2021 from just over half today. This shift has many structural benefits for the sector including the need for less S&M, higher R&D productivity and a greater ability to absorb price pressure.

Patent Cliffs Consigned to History – We show that there is no patent cliff over the next 8 years and argue that the uninterrupted period of EPS growth warrants a re-rating.

AZN & NOVN are top picks – AZN has improving quality of earnings & rapid growth whilst NOVN has multiple catalysts that could materially improve sentiment. We would avoid Sanofi on 2017 downgrade risk. GSK & ROG are rated Hold.