Japan Pharma Strategy: Is the Goldilocks Era Coming to a Close?

Over the past few years, Japan’s drug sector has enjoyed an extended honeymoon with investors. Understandably popular during the pre-Abe negative-inflation / rapidly-aging-population period, it continued to do well under the current government as a series of micro factors kicked in. An improvement in the FDA approval rate following the Vioxx[1] storm has driven up both top-line performance and margins, while a simplification of the domestic drug approval process has also helped. Growth in new markets has taken the edge off patent-expiry concerns, while licensing and acquisition processes have been significantly improved after the disasters of the previous decade. 
However, it is hard not to think that the sector has primarily won out with investors because it was a high but secure dividend yield sector at a time when, with negative interest rates and global eco-political worries, there has been a desperate search for yield. Yes, sector-wide operating profits are on the up; but they are still below where they were six years ago.
What we have seen, therefore, is a divergence between the market’s belief about how the sector has done in the real world – one based on the share price performance – and what has happened. Such a divergence is not unusual, and while there is an expectation that the situation should mean revert, it is not automatic either that mean-reversion will begin any time soon, or that the divergence won’t widen before it narrows.  
For some time, now, we have struggled to find names in the sector which either offer value or, at least, offer you a fair prospect of delivering the returns the stock price premiums indicate. However, there are now industry-specific reasons to be concerned about the sector, and these may precipitate such a mean reversion.