In August 2017, we wrote a piece about pricing pressure in the US generic drugs market. We focused on the acceleration in generic drug approvals, which is only one of the factors in today's deflationary environment. At the time, we did not believe we would see pricing equilibrium in the near-term under the current regulatory and business conditions, and predicted that prices for generic drugs would continue to decline until manufacturers gained negotiating leverage.
This scenario has played out, and the generic drug space remains under pressure. Large generic drug manufacturer Teva Pharmaceutical reported 4Q 2017 revenues fell -16% Y/Y primarily due to continued price erosion from generic competition. The company also guided to 2018E revenue of $18.3 - $18.8b versus consensus of $19.3b for the same reason. As a result, it said it would be cutting 14,000 jobs from its workforce, close or sell 12 of its plants by YE 2018, and scale back R&D. More recently, Teva's 2Q18 revenue fell -17.3% Y/Y and the company reported that its US generics business continued to face pressure. Sales of its leading product Copaxone were also hurt by generic competition and the outlook for the drug in 2H18 is bleak given sustained pressure from peers Mylan and Sandoz.
Meanwhile, drug distributors also foresee tough times in the generics space. Cardinal Health recently guided to lower-than-expected EPS partly due to generic pressure (although they say it is stabilizing somewhat), and AmerisourceBergen maintained its guidance for generic deflation of -7% to -9% and predicted sustained weakness for the foreseeable future.
Fears of the generic drug space have spread to the world of M&A. Rite Aid, which held a shareholder vote on August 9 to sell itself to Albertsons, recently lowered its FY19 guidance due to changes in generic drug prices. As such, even though proxy advisory firms recommended investors vote against the deal, shareholders had to weigh the risk of deteriorating fundamentals versus being bought by a firm owned by a private-equity company that wants to exit its investment.
Suffice it to say, the gloomy picture in US generic drugs is ongoing. While the drop in prices may not be as precipitous as last year, we reiterate our view that we won't see a bottom in prices until the drug manufacturers gain leverage through R&D, consolidation, or some exogenous regulatory action.
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As international equity investors, the team at R Squared Capital Management (former team at Julius Baer / Artio Global) utilizes fundamental and macro analysis in our quest to correctly identify structural tailwinds and headwinds at the geographic, sector and company levels.
FROM THE DESK OF DAEIL CHA
Daeil Cha is a Partner and Analyst at R Squared Capital Management.
Prior to joining R Squared, Daeil was an Analyst at Suffolk Capital Management.
Daeil received an MBA from Columbia University and a Bachelor of Arts in Psychology, with a focus on Neuroscience, from Princeton University.
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