VanEck logo
  • Moat Investing

    Innovation Fortifies Drug Company Moats

    Brandon Rakszawski, Senior ETF Product Manager
    13 August 2020
     

    The Morningstar® Wide Moat Focus IndexSM (the “Index”) has had an overweight position to the healthcare sector relative to the S&P 500 Index at many times historically. Often, its overweight has swung to an underweight if companies in the sector begin to appear less attractively priced based on the Index’s quarterly review process, which is intended to identify opportunities to allocate to undervalued wide moat stocks. In recent years, there has been a persistent overweight to health care stocks ranging from modest to significant. The Index’s overweight to healthcare registered at approximately 4% at the end of July but was as high as 10% earlier in the year and even higher in early 2018. This overweight is driven in large part by pharmaceutical and biotechnology companies.

    Morningstar’s healthcare strategist, Karen Andersen, and director of healthcare equity research, Damien Conover issued a report last week, “Innovation Supports Growth at Big Pharma/Big Biotech Companies,” covering many recent and current members of the Index.

    Patents and Pipelines 

    Drug companies tend to benefit from intangible assets, a source of economic moat, in the form of intellectual property, but may also reap the rewards from investment in innovation. Not only do many of these companies benefit from long-term patents on existing drugs, their research and development efforts to release new drugs can help offset margin pressures on existing drugs when patents expire and generic versions enter the market. 

    “Innovation is the central building block for the strong economic moats in the drug and biotechnology industry, supporting drug pricing power and launch trajectories. However, drug sales fall significantly following patent expirations, making the continuous cycle of new drugs essential to the industry’s economic moats,” stated Conover and Andersen. 

    They further explained that they believe wide moat drug company pipelines are positioned to support 5% annual sales growth, helping to offset upcoming patent losses and further reaffirming the companies’ moats.

    Pharmaceutical Moat Stocks with Strong Pipelines and Attractive Valuation

    Morningstar Analyst Research

    Merck & Co. (MRK)
    Price/Fair Value: 0.80

    Merck’s oncology portfolio (led by Keytruda) and diversification with strong vaccine and animal health units support strong long-term growth potential despite new competition.

    Patents, economies of scale and a powerful intellectual base buoy Merck's business and keep it well shielded from the competition. As the bedrock of Merck's wide moat, patent protection should continue to keep competitors at bay while the company strives to introduce the next generation of drugs. Further, the company's enormous cash flows support a powerful salesforce that not only sells currently marketed drugs, but also serves as a deterrent for developing drug companies seeking to launch competing products. The cash flows also put the company in the rare position of being able to support the approximately $800 million in R&D needed on average to bring a new drug to the market.

    Bristol-Myers Squibb Co. (BMY)
    Price/Fair Value: 0.86

    Bristol’s Celgene acquisition brought strong Revlimid cash flows and a late-stage pipeline launching in 2020-21 to counter Opdivo’s lung cancer disappointments and Bristol’s thinner pipeline.

    Based on a wide lineup of patent-protected drugs, an entrenched salesforce and economies of scale, Bristol holds a wide economic moat. The patent protection allows the firm to price its drugs at levels that translate into superior returns on invested capital compared with its cost (particularly in cancer drugs, an area of focus for Bristol). The patents also provide Bristol with ample time to bring forward the next generation of new drugs. Additionally, several of Bristol's currently marketed drugs are biologics, which create additional hurdles for generic firms, as the cost of developing and marketing biosimilars is much higher than for typical generic small molecules.

    Pfizer Inc. (PFE)
    Price/Fair Value: 0.91

    Pfizer’s immunology pipeline, led by atopic dermatitis drug abrocitinib along with an established and innovative vaccine platform, supports steady growth.

    Patents, economies of scale and a powerful distribution network support Pfizer’s wide moat. Pfizer’s patent-protected drugs carry strong pricing power that enables the firm to generate returns on invested capital in excess of its cost of capital. The patents give the company time to develop the next generation of drugs before generic competition arises. Additionally, while Pfizer holds a diversified product portfolio, there is some product concentration, with the company’s largest product, Prevnar, representing just over 10% of total sales. However, we don't expect typical generic competition for the vaccine, due to complex manufacturing and relatively low prices for the product. We expect new products will mitigate the eventual generic competition of other key drugs. Also, Pfizer’s operating structure allows for cost-cutting following patent losses to reduce the margin pressure from lost high-margin drug sales.


    Source: Morningstar Equity Research. Price/Fair Values as of July 31, 2020. Past performance is no guarantee of future results. For illustrative purposes only. Not a recommendation to buy or sell any security. Visit our fund page to view daily fund and index holdings.

    Executive Order Not Viewed as Major Impediment

    President Donald Trump signed several executive orders on 24 July 2020 targeting drug prices, which made for headlines, but Morningstar analysts see the orders creating only modest pricing headwinds and slightly higher uncertainty for drug firms. In short, it is not expected that the orders will significantly affect Morningstar’s fair value estimates or economic moat ratings.

    One order allows the import of drugs from Canada in an attempt to undercut U.S. pricing, which, according to Morningstar, is close to double that of international prices. However, two similar legislative attempts to enact the same pricing pressure failed previously at implementation due to safety concerns. A second order targeted drug rebates within the supply chain, but Morningstar believes it is unclear how eliminating drug rebates would affect net drug prices in the current complex system. Lastly, Morningstar does not believe the third order providing for insulin and epinephrine discounts will significantly impact drug companies.

    Other proposals and potential orders have been floated that may impact drug companies, but uncertainty remains. 

    VanEck Vectors Morningstar US Wide Moat UCITS ETF (MOAT) seeks to replicate as closely as possible, before fees and expenses the price and yield performance of the Morningstar Wide Moat Focus Index.

    Learn more about Moat Investing.


  • Important Disclosure

    For informational and advertising purposes only.

    This commentary originates from VanEck Investments Ltd, a UCITS Management Company under Irish law regulated by the Central Bank of Ireland and VanEck Asset Management B.V., a UCITS Management Company under Dutch law regulated by the Netherlands Authority for the Financial Markets. It is intended only to provide general and preliminary information to investors and shall not be construed as investment, legal or tax advice. VanEck Investments Ltd, VanEck Asset Management B.V. and its associated and affiliated companies (together “VanEck”) assume no liability with regards to any investment, divestment or retention decision taken by the investor on the basis of this commentary. The views and opinions expressed are those of the author(s) but not necessarily those of VanEck. Opinions are current as of the commentary’s publication date and are subject to change with market conditions. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. All indices mentioned are measures of common market sectors and performance. It is not possible to invest directly in an index.

    VanEck Vectors Morningstar US Wide Moat UCITS ETF (the “Fund”) is a sub-fund of VanEck Vectors® UCITS ETFs plc., organised under the laws of Ireland, managed by VanEck Investments Ltd. VanEck Investments Ltd delegated the investment management of the Fund to Van Eck Associates Corporation, an investment manager regulated by the U.S. Securities and Exchange commission (SEC). Any investment decision must be made on the basis of the prospectus and the key investor information document (“KIID”), which is available at www.vaneck.com. These are available in English and certain other languages at www.vaneck.com or can be requested free of charge from VanEck Investments Ltd or from the relevant local information agent details of whom to be found on www.vaneck.com. The Fund is registered with the Central Bank of Ireland and tracks an equity index.

    Morningstar® Wide Moat Focus IndexTM is a trade mark of Morningstar inc. and has been licensed for use for certain purposes by VanEck. VanEck Vectors Morningstar US Wide Moat UCITS ETF is not sponsored, endorsed, sold or promoted by Morningstar and Morningstar makes no representation regarding the advisability of investing in VanEck Vectors Morningstar US Wide Moat UCITS ETF.

    The S&P 500 Index (“Index”) is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Van Eck Associates Corporation. Copyright © 2020 S&P Dow Jones Indices LLC, a division of S&P Global, Inc., and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. For more information on any of S&P Dow Jones Indices LLC’s indices please visit www.spdji.com. S&P® is a registered trademark of S&P Global and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC. Neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors shall have any liability for any errors, omissions, or interruptions of any index or the data included therein.

    S&P 500® Index: consists of 500 widely held common stocks covering the leading industries of the U.S. economy. Morningstar® Wide Moat Focus IndexTM consists of at least 40 U.S. companies identified as having sustainable, competitive advantages, and whose stocks are the most attractively priced, according to Morningstar.

    All performance information is historical and is no guarantee of future results. Investing is subject to risk, including the possible loss of principal. You must read the Prospectus and KIID before investing in a fund.

    No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck.

    © VanEck Investments Ltd / VanEck Asset Management B.V.