Stocks of big pharmaceutical companies have been core holdings in many portfolios for as long as I can remember, probably even beyond that. The reasons are crystal-clear: an ever aging population, more chronic diseases also among younger generations, stable to slightly rising demand throughout the business cycle, relative price stability of those stocks and reliable dividends. What’s not to like?

Summary and key takeaways from today’s Weekly
– Stocks of Big Pharma companies can be found in many portfolios. The main reasons are business and dividend reliability.
– But what many don’t seem to be aware of is that these companies face massive patent cliffs that will force them to acquire new sales, just to maintain the current status quo. There is much room for destruction of shareholder value with ill-timed and over-paid takeovers.
– Organic developments haven’t been very promising over the last ten years in most cases. Free cash flows didn’t grow much or were in some cases supported by one-time effects.

As my readers know, I strive for more. I tend to question narratives and the current status quo while looking for under-penetrated, under-looked opportunities. Seldom, if ever, will you find a bargain where nearly everyone is already invested.

This time, I had a look at the “Big Pharma” companies.

For many, buying these stocks is a no-brainer as they seem to have relatively low risks, but stable to slightly growing businesses. They are also known to be reliable dividend payers. That’s why they are often found and presented as core holdings – because one allegedly cannot do wrong with them.

But let’s face the truth.

These companies lack attractive organic growth stories and occasionally tend to do big acquisitions while diluting existing shareholders through paying with own stock and / or taking on huge debt. The time of cheap debt is over, now.

And as you will see in this article, M&A (mergers and acquisitions) activity likely is going to heat up again, as many patents are due to expire in the next years. Big sales losses are coming – replenishing the pipelines will be costly!

Besides, they often rather rely on price increases while true organic growth – I am talking of more than 10% p.a. – isn’t really there.

And of course, these stocks in many cases are already richly priced, especially compared to their growth prospects. It pains me to see buybacks at these elevated levels, though dividends are the preferred choice for shareholder returns.

In this Weekly, I will give you an overview of the biggest Pharma companies and throw some numbers around. I did a screen (using Finviz, see here) and selected my candidates for today by the biggest market capitalization. I excluded health insurance, medical equipment and medical distribution companies.

The focus was purely on well-known developers and producers of pharmaceuticals.

After reading this latest Weekly, you maybe will see that the big names aren’t really attractive for investors, but will even be dangerous and risky over the next years as there is much potential for destruction of shareholder value with ill-timed under-pressure acquisitions.

The good news is, I am going to publish my next research report about a founder-led pharmaceutical company that I have been already observing for around five years. It is operating in a lucrative niche where the big boys have not so much interest, because it doesn’t move the needle for them.

My pick is leading in its niche and has:

• an organic growth story already under way
• after a long sideways stretch, the company found back to growth with an approval for a new indication last year – this company is the only one to have an approved drug for this disease (no competition)
• further huge potential due to likely enlarging the area of application of its now most important drug in the medium term (the clinical studies have been promising)
• beyond that in the long term, the whole business could multiply and lift the company and its stock into completely new dimensions, if its organ manufacturing business takes off – first results are there
• the company has a big net cash position of 30% of its market capitalization on its balance sheet
• self-explanatory, it is an established business, generating strong free cash flows

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A brief overview of my Pharma picks

To not make it too complicated, I just chose “healthcare” as my only parameter to filter through the universe of stocks that Finviz offers.

I sorted them by market capitalization.

Then I manually put those which do not develop and manufacture drugs to the side.

That’s it!

Why and how FinViz distinguishes between Biotech and Pharma is not so clear to me, as I certainly see more biotechs in this list. But let’s leave it with this. I put them all into the “healthcare” category for simplicity.

What was left for me to have a closer look at, is this list of ten:

1. Johnson & Johnson
   (ISIN: US4781601046, Ticker: JNJ)
2. Eli Lilly
   (ISIN: US5324571083, Ticker: LLY)
3. AbbVie
   (ISIN: US00287Y1091, Ticker: ABBV)
4. Merck
   (ISIN: US58933Y1055, Ticker: MRK)
5. Novo Nordisk
   (ISIN: DK0060534915, Ticker: NOVOB)
6. Pfizer
   (ISIN: US7170811035, Ticker: PFE)
7. Novartis
   (ISIN: CH0012005267, Ticker: NOVN)
8. AstraZeneca
   (ISIN: GB0009895292, Ticker: AZN)
9. Bristol-Myers Squibb
   (ISIN: US1101221083, Ticker: BMY)
10. Amgen
    (ISIN: US0311621009, Ticker: AMGN)

You will have noticed that seven of the ten are US companies, while the rest is from Denmark, Switzerland and UK / Sweden (one each).

All these companies are old and all of them have done some sort of acquisitions over time to buy new growth. None of these companies is founder-led anymore and also most of them have pharmaceuticals for several different, not necessarily complementary areas of diseases and illnesses in their portfolios.

Likewise, many are in direct competition with each other.

These are really big fish where it is difficult and time consuming to get an overview of what they are exactly offering. Here are a few sentences to each of them for starters, before we get more into the numbers.

Johnson&Johnson

The biggest company by market capitalization and one of the dividend darlings is JNJ.

However, it is not a pure Pharma company as it is also producing medical instruments and consumer health products for baby care, oral care, skin care or flu treatments. It also is offering sanitary, allergy and smoking cessation solutions. All in all, a wide portfolio. The consumer health division is about to be spun off in the next quarters.

In its pharmaceutical portfolio (the single biggest division with the highest margins), JNJ has treatments for infectious, chronic and inflammatory issues, but also for cancer or neurodegenerative disorders.

There is even more than that. But you see the main point. It is a really big healthcare powerhouse. The two most important subsegments from its Pharma division are immunology and oncology, together generating ca. 63% of sales.

Eli Lilly

The second biggest by market cap is Eli Lilly. It is mainly known for its diabetes / insulin franchise which generates around half of total revenues. But Lilly – as it is also often called – likewise has cancer and immunology treatments as well as for some other illnesses.

The first two (diabetes and cancer) are the biggest segments, totaling more than 70% of revenues. Lilly also has some COVID antibodies in ins assortment which last year accounted for around 7% of sales, mainly in the US.

These extra sales, however, should subside over time.

AbbVie

AbbVie, prior to its own listing, was the biotech division of Abbott Laboratories (ISIN: US0028241000, Ticker: ABT). Originally, ABBV focussed primarily on immunology and to a lesser extent also on oncology.

But as its best-selling drug Humira (immunology) with its around 20 bn. USD in yearly revenues loses its exclusivity in the US this year, ABBV had to act in advance. Competition is fierce and cheaper off-patent solutions are standing on the sidelines to take meaningful revenue.

For years, Humira has been even the best selling drug worldwide.

This shows how urgent it was for ABBV to replace its heavy reliance on this product. It developed two own second generation solutions, which are growing fast, but so far could not replace Humira entirely.

Further, ABBV made a big acquisition when it bought botox-maker (among others) Allergan for 63 bn. USD in 2020 to diversify its portfolio. Besides issuing shares at rather low prices, ABBV also took on a huge debt load it is still digesting today.

Merck

Merck’s best seller, Keytruda, a cancer therapy, is close to overtaking AbbVie’s Humira for the top spot this year. Last year, it already crossed the 20 bn. USD mark in sales for the first time, but overall was slightly behind Humira.

Keytruda generated a third of Merck’s total sales in 2022. This product is still growing.

Merck has also vaccines and some virology, immunology and diabetes drugs in its portfolio. But the superstar is and remains Keytruda for years to come.

Keytruda was acquired in 2009 (see here).

Novo Nordisk

Novo is also primarily a “diabetes company”. This sector accounts for around 80% of total sales. After a rather sluggish growth profile until 2020, this sector got wind under its wings again and growth rates accelerated into double digit territory.

Besides, it also has growth hormones, weight loss (“obesity care”) and some rare disease drugs to offer.

Novo is primarily a company with a strong and defensive balance sheet as well as own-developed drugs, whereas most other companies we discuss here had sooner or later some sort of acquisition.

Even Merck bought a formerly hopeless Keytruda and hit the jackpot.

Pfizer

Pfizer should be known at the very least for its covid vaccine and pill that generated massive extra revenues and profits in the last two years. Both also currently are the two biggest revenue generators. As I expect them to decline meaningfully over time, a look at what PFE has besides these two in its portfolio is necessary.

The biggest non-covid products from PFE are a thrombosis / blood thinner drug, a Streptococcus vaccine and a breast cancer drug, all having more or less the same size (in slightly descending order). While the first two are growing, the latter does not anymore.

All other products are way smaller.

Novartis

The Swiss giant has two segments, one called “Innovative Medicine” (ca. 80% of revenues) and its generic drug division Sandoz that is said to be spun off, soon.

Novartis also has many subdivisions with several drugs. The biggest field of treatment is immunology, followed by hematology (skin diseases), but it also has cancer therapies and neuroscience products – among others.

It is all in all one of the more diversified companies, but it also lags a clear winner that is pulling the whole company.

AstraZeneca

This Britsh-Swedish duo is also a pretty diversified company with oncology being its biggest division (ca. a third of revenues). The other therapeutic areas are CVRM (Cardiovascular, Renal and Metabolism), respiratory and immunology, vaccines and rare diseases.

Of its in total 42 bn. USD in sales, the oncology drug “Tagrisso” is the only one with more than 5 bn. USD in revenues.

There is only one other drug with more than 10% of revenues.

Bristol-Myers Squibb

BMY offers products for hematology, oncology, cardiovascular, immunology, fibrotic, and neuroscience diseases. Thus, it also has a broad portfolio.

The company’s top seller of 2020 and 2021, revlimed (with nearly 25% of overall revenues), a blood cancer therapy, lost its exclusivity last year. This could be felt insofar, as total revenue growth came to a standstill in 2022, despite strong growth from its former number two that now sits in the top spot.

Bristol-Myers Squibb is also historically a company which is not shy to acquire other Pharma companies. The last big acquisition was that of Celgene which owned the product revlimed. The transaction value – a mix of cash and stock – was more than 70 bn. USD in 2019.

One of the biggest transactions, ever!

Amgen

Amgen is also one of the more diversified companies. It focuses among others on inflammation, oncology, hematology and cardiovascular diseases.

Currently this company is not growing, because big revenue generators are declining due to loss of exclusivity, while newer drugs try to catch up. Its two most important drugs together accounted for nearly 25% of revenues while its top ten products bring in 80% of revenues.

Interesting and somewhat funny fact: Due to its top seller being in decline, Amgen diversifies itself.

The key takeaway is that – with the exception of the two “diabetes companies” Lilly and Novo – all other Pharma giants are rather broadly diversified, but lack a clear, dominating focus. I define this by having a franchise / division that brings in at least 50% of revenues on a sustainable basis.

However, this does not mean that some companies are not highly dependent on one or two drugs.

With this, let’s look at some numbers that tell us how thee companies are doing operationally.

What you should be aware of about Big Pharma

Let’s start with what most investors probably will look at first – and unfortunately in some cases the only parameters – some valuation metrics and the dividend yield:

Company	PE*	EV / FCF	Dividend Yield
Johnson&Johnson	22.9x	21.8x	2.9%
Eli Lilly	46.2x	54.8x	1.2%
AbbVie	23.5x	14.6%	3.7%
Merck	18.7x	22.8x	2.6%
Novo Nordisk	41.3%	39.6x	1.2%
Pfizer	7.5x	9.9x	3.9%
Novartis	26.7%	18.2x	4.1%
AstraZeneca	61.5%	15.2x	2.2%
Bristol-Myers Squibb	23.5x	12.3x	3.2%
Amgen	19.4x	17.7x	3.3%

You shouldn’t be irritated by massively diverging PE and EV / FCF ratios.

The former does not look at the debt position, only the equity value for which stocks currently change hands. Plus, PE ratios are negatively influenced by acquisitions, when the acquirer paid a high price and subsequently has to write off gradually (impair) the value of certain intangible assets like patents or trademarks which these types of businesses mainly have on their balance sheets.

That’s also the reason why you will see many adjusted numbers in the reporting.

EV / FCF is the better and more precise metric.

What we can take home at this point:

• all companies offer lower dividend yields than US government bonds (!)
• the two “diabetes companies” are the most expensive ones, both having the highest multiples and only offering a 1.2% dividend yield at current prices, each
• AbbVie, AstraZeneca and Bristol-Myers Squibb have huge differences between their PE ratios and EV / FCF; this is because they are still digesting their expensive acquisitions which ballooned their balance sheets. The trio has to amortize certain assets (amortization = depreciation of intangible assets) from prior acquisitions which is added back up in the cash flow statement.
• Pfizer seems ultra cheap, but keep in mind that this over-exaggeration will re-balance
• all other somewhat trade for multiples and dividend yields that are on a comparable level

When you have a low PE ratio, this doesn’t necessarily mean that the price is low. Earnings could be too high, which does not bode well for the stock.

Next, let’s look closer at market caps, debt and free cash flow:

Company	Market Cap (USD)	Net Debt (USD)	Free Cash Flow (USD)
Johnson&Johnson	401 bn.	17.4 bn.	19.1 bn.
Eli Lilly	287 bn.	14 bn.	5.5 bn.
AbbVie	276 bn.	55 bn.	22.7 bn.
Merck	271 bn.	19 bn.	12.7 bn.
Novo Nordisk*	325 bn.	–	8.3 bn.
Pfizer	231 bn.	17 bn.	25 bn.
Novartis*	180 bn.	9 bn.	9.7 bn.
AstraZeneca*	201 bn.	25 bn.	12.3 bn.
Bristol-Myers Squibb	145 bn.	32 bn.	13.8 bn.
Amgen	125 bn.	30 bn.	8.7 bn.

Here, we see that:

• the strongest balance sheets (with net debt being less than 1x free cash flow) belong to JNJ, Novo, Pfizer, Novartis
• before covid, Pfizer had a free cash flow of around 10 bn. USD. This means their valuation as well as their debt to free cash flow should change in the next quarters to the worse
• especially Eli Lilly, AbbVie, Bristol-Myers Squibb and Amgen have rather a high debt load, measured against free cash flow generation

And now, let’s look at the fundamental developments over the last ten years, as metrics like these from above must always be put into context, i.e. compared to growth.

We look at charts this time, because these information are quicker to grasp.

Don’t spend to much time on it, just look quickly at the trends of revenues (blue lines) and free cash flows (dark grey columns).

Below, I will summarize the key points.

Johnson&Johnson

Eli Lilly

AbbVie

Merck

Novo Nordisk

Pfizer

Novartis

AstraZeneca

Bristol-Myers Squibb

Amgen

Key points to take home:

• the companies with strong revenue growth over the last ten years are Johnson&Johnson, Lilly, AbbVie, Merck, Novo, Pfizer, AstraZeneca, Bristol-Myers Squibb and Amgen – i.e. all except one
• not growing over a decade has been Novartis
• if you take into account / adjust revenue growth for covid effects, then JNJ, Pfizer and AstraZeneca haven’t grown very much, either
• thanks mainly to its best-selling drug Humira, AbbVie was able to grow strongly, but they were more or less forced to buy Allergan
• AbbVie and Bristol-Myers Squibb had expensive acquisitions and took on much debt for them each, but were able to boost revenues and free cash flows, at least for the time being
• what remains are the two “diabetes companies” Lilly and Novo Nordisk as well as Merck and Amgen which for the most part have grown organically or at least only supported by in comparison smaller acquisitions (Amgen)
• Novo Nordisk and AbbVie grew free cash flows organically, AbbVie also and Bristol-Myers Squibb especially due to their acquisitions; JNJ, Pfizer and AstraZeneca were booste(re)d by covid
• all other companies struggle to increase their free cash flows!

You see, “true” organic growth is rather a difficult chapter for these companies.

Novo Nordisk with its highly focussed operations is an exception. However, it is also priced for perfection already.

What these big Pharma companies rather are doing is maintaining their position and when their products are about to lose patent protection, they are forced to acquire growth externally.

To assess whether there is some potential hidden in the companies’ pipelines, I went through two special reports of Evaluate Pharma, a service that “collects, calibrates and connects the pharmaceutical world’s data”. This is a really precious source of information for those interested in Pharma, Biotech and the like.

So, what has the potential to launch in 2023?

Eli Lilly seems to have two projects in its late stage pipeline that could come to market this year. Lilly has among the lowest revenues from the companies in the list, hence it could indeed grow somewhat organically. But the rest either has nothing or it likely won’t contribute that much to the overall higher revenue bases.

But notice that the revenue estimates are only for 2028!

What’s beyond this in the pipelines with big potential value?

You see that only JNJ seems to have two bigger promising projects in its quiver. NPV stands for “net present value”, i.e. it is a value, estimated / calculated, based on certain assumptions, for the entire life of the product, discounted back to today.

In short: You check what future free cash flows – under subjective assumptions – are worth today.

In a second report (see here), titled “WORLD PREVIEW 2022 Outlook to 2028: Patents and Pricing”, on p. 6 the authors write:

M&A is also reviving as big pharma wakes up to the potential sales losses facing it over the next decade (see Figure 7 “sales at risk” on page 14) and puts to work the estimated $500 billion cash at its disposal before it is inflated away. 

Evaluate Pharma, report “WORLD PREVIEW 2022 Outlook to 2028: Patents and Pricing“

The “potential sales losses” are coming patent expirations.

Here is the mentioned “Figure 7” from the report:

You see that in 2023 already 5% of world Pharma sales will start losing patent protection. The most prominent drug is AbbVie’s Humira. 5% doesn’t sound like much, but it is the equivalent of ca. 80 bn. USD in sales (!).

After a calmer 2024, in the next years, expirations will strongly rise again.

Evaluate Pharma also had an article last year, touching this topic:

In this article, they warn about “the most painful period of patent loss for at least 30 years”.

Wow.

A quote from this article (bold passages highlighted by me):

[…] And what do large developers do when confronted with a revenue gap? They make acquisitions. This approaching wave of expiries is already being cited by those keen to see an uptick in M&A, and in many ways the need to replace sales provides a more convincing motivation for dealmaking than tumbling biotech valuations.

Evaluate Pharma, “The patent winter is coming” (see here)

And here is a table from the same article showing the most at risk patents in the mid-term:

AbbVie, Merck and Bristol Myers Squibb are the three where LOE (loss of exclusivity, i.e. a patent expiry) will probably cause the biggest pain – and put pressure on M&A activities. Especially AbbVie and Bristol-Myers Squibb with their already stretched balance sheets should have issues.

Keep also in mind that this overview is already one year old. For example, both Humira and Keytruda, generated more than 20 bn. USD in 2022.

Not on this list – but I checked it for you – is Pfizer.

Their three biggest non-covid drugs (together around a third of revenues prior to covid) are set to lose market exclusivity in 2026 and 2027.

You see, the writing is already on the wall. One just needs to read it and draw the right conclusions from it. With investments in stocks of Big Pharma, you either buy companies not growing anymore, priced to perfection or very risky ones that will be forced to go on shopping trips just to replace their crumbling sales.

They already had to between 2011 and 2015.

But this time it will be a tougher task as quantitively more and more valuable patents expire. Likewise, the coming M&A wave will have to be conducted in a rising (or higher) interest rate environment – not in a near zero one.

You can also be sure that deals won’t be cheap for promising assets. Plus, in order to move the needle for the big boys, acquisition targets will cost them pretty surely double digit figures. Maybe even more than 25 bn. USD – per acquisition.

I wouldn’t also be surprised to see 50+ bn. USD deals.

There is much potential for destruction of shareholder value due to poor and costly deals under pressure.

That’s why I am staying away from Big Pharma.

There is not much to gain, but much to lose! Generics and likely destructive deals are coming.

And this is also why I have let my brain work full steam to find a clever solution from this sector.

Guess what, I managed to find one!

My pick is leading in its niche and has:

• an organic growth story already under way
• after a long sideways stretch, the company found back to growth with an approval for a new indication last year – this company is the only one to have an approved drug for this disease (no competition)
• further huge potential due to likely enlarging the area of application of its now most important drug in the medium term (the clinical studies have been promising)
• beyond that in the long term, the whole business could multiply and lift the company and its stock into completely new dimensions, if its organ manufacturing business takes off – first results are there
• the company has a big net cash position of 30% of its market capitalization on its balance sheet
• self-explanatory, it is an established business, generating strong free cash flows

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Conclusion

Stocks of Big Pharma companies can be found in many portfolios. The main reasons are business and dividend reliability.

But what many don’t seem to be aware of is that these companies face massive patent cliffs that will force them to acquire new sales, just to maintain the current status quo. There is much room for destruction of shareholder value with ill-timed and over-paid takeovers.

Organic developments haven’t been very promising over the last ten years in most cases. Free cash flows didn’t grow much or were in some cases supported by one-time effects.

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