Opportunities and risks of the healthcare sector
By Sebastian Hofbeck, Analyst and Portfolio Manager at DJE Kapital AG
Diabetes and obesity continue to dominate the healthcare sector. A recent study by Goldman Sachs shows the incredible potential that the market for obesity drugs alone - also known as weight loss drugs - has. The investment bank's analysts assume that the market will grow from just under 14 billion US dollars in 2024 to more than 130 billion US dollars in 2030. It is therefore understandable that many pharmaceutical companies are conducting research in this area. There has been some positive study data on obesity drugs in recent months. However, the main beneficiaries are still Eli Lilly and Novo Nordisk, which are the only companies already marketing their products Zepbound (Eli Lilly) and Wegovy (Novo Nordisk) and will be alone in this market for a few more years, as potential competitors are only in the early research phases.
The growth potential of these two pharmaceutical companies can also be seen in the current prescription trends. Prescriptions for both diabetes and obesity drugs in the US rose sharply in the first half of 2024: Zepbound and Wegovy achieved growth of more than 50 percent in Q2/2024 compared to Q1/2024, with only around five percent of obese people in the US currently being treated with Eli Lilly or Novo Nordisk drugs, and significantly fewer internationally. The biggest challenge for the two companies therefore remains to be able to meet this enormous demand. To this end, Eli Lilly and Novo Nordisk are investing a lot of money in production capacities and in the acquisition of other companies. Whether these investments will be sufficient remains to be seen.
Production capacities and a broad development pipeline are an advantage
The large investments in production capacities lead to a competitive advantage. The production process is complex and difficult to scale up. The production of the active pharmaceutical material, the core of a drug, is divided into the steps of fermentation, recovery and purification. Novo Nordisk believes that purification, i.e. the removal of harmful impurities such as unwanted animal proteins from the active pharmaceutical ingredient protein, is a major advantage because the necessary expertise has to be built up over many years. Furthermore, according to the two companies, setting up a factory takes between three and four years at best. Another competitive advantage for the two companies is the many successful studies on the additional benefits of the treatment. Among other things, Novo Nordisk was able to demonstrate a benefit for the cardiovascular system in the SELECT study: The cardiovascular risk of obese Wegovy patients was reduced by 20 percent. A 20 percent lower probability of suffering a heart attack or stroke is a strong argument. This has led to increased coverage by health insurance companies in the USA. It is likely that in future every obesity drug will have to undergo a cardiovascular benefit study, which is expensive and time-consuming. Eli Lilly was also able to show in a recently published study that its molecule has various additional benefits, including for sleep apnea. In addition, the two companies are already researching the next generations of diabetes and obesity drugs and are therefore once again one step ahead of their potential competitors. Novo Nordisk's next important development study is expected at the end of this year. Novo Nordisk hopes to show a weight loss of more than 25 percent in obese people without diabetes. The products currently available on the market achieve a weight loss of "only" 15 to 20 percent.
One reason why the share prices of Eli Lilly and Novo Nordisk have risen faster than those of many other pharmaceutical stocks in the past is their broad development pipeline. The same applies to various other companies in the pharmaceutical sector. AstraZeneca was able to inspire the capital market with its Vision 2030. The British company aims to achieve sales of more than 80 billion US dollars by the end of the decade, which corresponds to average growth of more than eight percent per year. This would be the best growth in the pharmaceutical sector alongside Eli Lilly and Novo Nordisk. The most important growth drivers are expected to be the oncology, biopharmaceuticals and rare diseases divisions.
US election campaign inhibits pharmaceutical shares
In the past, pharmaceutical shares have underperformed the rest of the healthcare sector in US presidential election years. One reason for this is that the reform of the healthcare system is often an election campaign issue. The focus has often been on reducing costs - both for each individual insured person and for the healthcare system in general. Most proposals would have reduced the profits of pharmaceutical companies as a result. Drug prices are once again an issue in the current election campaign, when incumbent US President Joe Biden and Senator Bernie Sanders published a commentary on "USA Today". In this article, they called for the prices of prescription drugs to be significantly reduced. They addressed Novo Nordisk directly, which led to a brief sell-off in the share price. However, unlike in previous election campaigns, even more drastic proposals are not to be expected, as US President Joe Biden already signed the Inflation Reduction Act (IRA) in August 2022.
The IRA is intended to reform the state health insurance program Medicare. The core intentions are to cap the price increase of drugs, limit the maximum co-payment for drugs by the individual insured person and conduct so-called price negotiations between the Center for Medicare and Medicaid (CMS) and the pharmaceutical companies concerned. Capping drug price increases to the level of inflation is generally considered to be uncontroversial. In contrast, capping copayments for individual drugs was a major issue in the first half of 2024. Some pharmaceutical companies have warned of the impact next year. According to estimates by some investment banks, the cap on co-payments will impact the affected pharmaceutical companies with up to three percent less sales growth in 2025. This is higher than previously expected and has led to a negative share price reaction from the pharmaceutical companies affected. The big unknown remains the impact of the so-called price negotiations. In these price negotiations, the CMS can push for a price reduction for selected prescription drugs. The pharmaceutical companies must agree to this price reduction, otherwise there is a risk of significant penalties. The first "negotiations" for the prices from 2026 are currently underway. According to the current schedule, the prices for the first ten selected drugs are to be announced in September 2024. Initial statements from affected companies, including the CEO of AstraZeneca, suggest that the price reductions will be smaller than feared.
US-China conflict also has an impact on supply chains
In recent years, China has developed into an important market for international healthcare companies. Regulatory reforms and higher quality standards have facilitated market access to this huge market. At the same time, many large international pharmaceutical companies are now working with contract research organizations and contract manufacturers from China, partly because they are cheaper and can address the local market more easily. US politicians now want to restrict this collaboration through the "Biosecure Act". From 2032, Chinese companies that are classified as questionable are to be denied access to federal contracts. Should the Biosecure Act actually come into force, this would lead to major changes in the supply chains. If you talk to pharmaceutical and other healthcare companies, they are already seeing the first effects. It remains to be seen whether and in what form the Chinese government will react.
Conclusion
Although a reform of the US healthcare system is not yet a major election issue, this could change in the course of the election campaign. The extent to which this will deter investors remains to be seen. However, the greater risk probably comes from the results of the "price negotiations" in the course of the IRAs. At the same time, an intensified discussion about the healthcare system should help medtech and life science companies, as it has in the past. At the same time, China is expected to launch a new stimulus package to boost the weakening economy. Equipment manufacturers in the healthcare sector should also be able to benefit from this. Overall, it is important to take advantage of these opportunities in the second half of the year, even though diabetes and obesity drugs are likely to remain the dominant theme in this sector.
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