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Why the Price Is Right for Drug Companies

Gilead Sciences is one of the large biotech companies that offers dividend yields above the benchmark U.S. Treasury note.
ENLARGE

Gilead Sciences is one of the large biotech companies that offers dividend yields above the benchmark U.S. Treasury note.


Photo:

Eric Risberg/Associated Press

By

Charley Grant

July 20, 2016 10:30 a.m. ET

Drug manufacturers continue to rely on pricing power to help top investor expectations. That may not be as big a short-term problem as some investors fear.

Prices of medicines remain in focus ahead of second-quarter earnings season. The Wall Street Journal reported last week that more than two-thirds of the 20 largest pharmaceutical companies boosted revenues from major products in the first quarter by raising prices. The Bureau of Labor Statistics’ Producer Price Index showed a nearly 6% rise in pharmaceuticals prices from June 2015 through June 2016, well above broader inflation rates. Since prescription drugs generally carry a high gross profit margin, these price raises tend to flow through to the bottom line.

What is more, new breakthroughs of economic consequence have lately been relatively scant, following a wave of significant medical innovation that fueled years of high returns in the sector. That increases the temptation to generate growth by raising prices.

It also poses a potential problem. Price increases are a controversial tactic; politicians have sharply criticized pharma companies since last summer. The coming U.S. presidential election means drug pricing is likely to remain a topic of interest in Washington. A sea change in government policy, such as allowing Medicare to negotiate prices with manufacturers, would certainly be problematic for big pharma and biotechnology stocks.

Yet harsh rhetoric and significant action are two different things. Concrete signs of a potential government crackdown on unregulated pricing are nowhere to be found. After all, complaints about big pharma’s business practices aren’t new, and it is unclear why this time should be different.

Meanwhile, across the stock market, investors are willing to pay up for stocks with flat or modest growth. Led by stodgy stocks with relatively high dividend yields, the S&P 500 has made new highs, amid falling sales and corporate profits. Big pharma certainly fits the yield bill; and large biotechs such as Amgen
AMGN


0.14
%




and Gilead Sciences
GILD


0.62
%




both offer dividend yields above the benchmark U.S. Treasury note.

Expected earnings growth is fairly strong, considering the broader economic environment. S&P Global Market Intelligence expects health-care earnings per share to rise by 6.5% in 2016, higher than all but one market sector.

Absent a sudden shift in the political landscape, pharma companies are likely to continue to use their pricing power with enough restraint to avoid more than a scolding. That should keep investors happy.

Write to Charley Grant at [email protected]

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Why the Price Is Right for Drug Companies Reviewed by on . ENLARGE Gilead Sciences is one of the large biotech companies that offers dividend yields above the benchmark U.S. Treasury note. Photo: Eric Risberg/Associated ENLARGE Gilead Sciences is one of the large biotech companies that offers dividend yields above the benchmark U.S. Treasury note. Photo: Eric Risberg/Associated Rating:
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