Drug-price inflation, a source of profit and headaches alike for the pharmaceutical industry, is slowing down. That might be better news for investors than it seems.
As has become customary, drug manufacturers raised the sticker price on many medicines as the calendar turned to 2020. Analysts at Morgan Stanley found 2,167 price increases in the first week of January, up 17% from the same period a year earlier.
The magnitude of those increases is fairly mild, however: The vast majority were less than 10% and nearly half were lighter than 5%. And since list-price increases come before rebates and discounts paid to middlemen in the drug supply chain, the drug manufacturer might pocket just a fraction of the extra money.
Lighter drug-price inflation, all else being equal, crimps the industry’s profits, and it is possible that some manufacturers will issue disappointing 2020 financial guidance. But with an election looming, investors should be willing to accept a loss of short-term earnings power to avoid attracting unwanted attention from Washington and the resultant threats to the industry’s business model.
After all, harsh scrutiny from politicians during the 2016 presidential campaign helped cause a sharp industrywide selloff. Back then, retail spending growth on prescription drugs had just topped 13% and 8% in 2014 and 2015, respectively, according to Centers for Medicare and Medicaid Services data.
But this time around, the industry has a much stronger case to avoid price-control legislation. Retail spending on prescription drugs has grown much less quickly than hospital or physician services since 2016. That trend seems likely to continue in 2020.
A round of mild price increases doesn’t guarantee a good year for everybody, of course. Presidential candidates may choose to hammer the industry anyway, despite the recent moderation. Drug distributors including McKesson (MCK), AmerisourceBergen (ABC) and Cardinal Health (CAH) also benefit from higher drug prices. Weaker profits for the distributors would look less attractive if a comprehensive deal to resolve opioid litigation with thousands of U.S. cities and states can’t be reached.
Elsewhere, speculative biotechnology stocks aren’t likely to perform well if the overall stock market starts to weaken, which is more than an idle risk after a prolonged bull run. Pharmaceuticals giants Johnson & Johnson (JNJ) and Bayer (BAYRY) each face potentially expensive litigation surrounding their iconic baby powder and weed-killing products, respectively.
But given the memories of last election cycle, investors should welcome a more restrained environment. This time, leaving some money on the table might prove to be a wise business choice.
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