Stockwatch: Earnings Season Appears Not At Home To Brexit

Novartis AG beat Johnson & Johnson (J&J) into second place by a few hours in being the first big life sciences company to report second-quarter earnings. Novartis' sales and earnings beat analysts' consensus estimates by 2% and 3%, respectively. As usual there was a strong performance from its pharmaceutical and also (going against recent history), at its generics division Sandoz, Inc. The hoped for turnaround at the eye care division Alcon had largely still not materialized. When I read Novartis' earnings announcement, I thought that the results were good against my expectations of a Brexit-induced guidance downgrade and although its full-year guidance was lowered slightly, it was on the basis of Novartis' increased primary care investment on Entresto (sacubitril/valsartan) for heart failure after its elevation in recent guidelines.

Since our fund holds neither Novartis nor J&J I started to wonder if I had missed out this earnings season's early highlights. However, on that day the Novartis stock price finished about where it started. When I read analysts' reportage on Novartis' results, I began to detect a nonplussed stance. The analysts at Citigroup entitled their note "2Q Good Enough" but described the results as "robust". Entresto sales were $32m, missing consensus estimates of $35m. This is a disappointing launch in big pharma terms and the specter of this great white hope product for Novartis never meeting its lofty expectations may have been part of the Citigroup analysts' caution. Their lack of enthusiasm was mirrored by the analysts from JP Morgan, whose note was entitled "2Q16 Results First Take: Good Enough" and attributed Novartis' performance to a lower than expected Gleevec (imatinib) generic erosion – ironically a theme that also helped Swiss compatriot Actelion Pharmaceuticals Ltd. when it reported later in the week.

With the new threats of drug pricing sensitivity and biosimilar competition that pharmaceutical and biotechnology companies face, it was somehow reminiscent to find the old classic threat of generic expiry permeating through the early part of this results season. Ironically, Novartis is a past master at benefiting from delayed competition to its hypertension franchise: manufacturing problems at Ranbaxy Laboratories delayed a generic to its hypertension drug and Entresto component Diovan (valsartan) until the expiry of the 180-day exclusivity period. (Also see "STOCKWATCH: J&J points to medtech dip, Novartis lobs MS grenade to Teva" - Scrip, 24 Jul, 2013.) This benefit from delayed generic competition by either the mistakes of other companies (in Novartis' case), or a dragging of feet on licensing Tracleer's (bosentan) REMS program (in Actelion's), or even the unsuccessful attempt to hang a new orphan exclusivity period on the out of patent statin Crestor (rosuvastatin) (by AstraZeneca PLC ) seems to have lost some currency with investors. Like Novartis, despite reporting good results last week, the Actelion share price finished just into positive territory on the day of its announcement.

With a company as big and diverse as Novartis, it is always possible to find something to critique in a quarterly results announcement and although the FDA's complete response letter for Sandoz International GMBH's biosimilar of Amgen Inc. ’s Neulasta (pegfilgrastim) was certainly unwelcome, its low profile in Novartis' results was perhaps a bigger component of the lackluster response to the results announcement. (Also see "Sandoz's Biosimilar Rejection Ups Risks, But Won't Kill Market" - Scrip, 19 Jul, 2016.) The analysts at JP Morgan described the 5% generic price erosion at Sandoz as "supportive of relative stability in the generic pricing environment for the large, diversified manufacturers". I tend to disagree since the generic pricing model is built upon the yin of new generic product launches (with hopefully 180 day, first-to-file exclusivity periods) against the more recent yang of generic price deflation. The fact that new ANDAs are unpredictable, especially with the Office of Generic Drugs’ backlog, but that generic price deflation is now recurring with -5% declines happening all year every year means that eventually the pure-play generic pharmaceutical company will not have the earnings growth trajectory that investors demand from this sector.

J&J's second-quarter results had a similar initially positive feel to those of Novartis, except that its share price finished up about 0.5% on the day. J&J reported stronger results than Novartis with sales and earnings that beat analysts' consensus estimates by 3% and 5%, respectively. Like Novartis, J&J raised full-year earnings guidance but also like Novartis there was an aspect that seemed to be underplayed and absent from the notes I read from the analysts at Cowen and UBS. J&J's results were flattered by a one-off $170m gross-to-net adjustment that comprised 76% of the beat of its best-performing pharmaceutical division. Gross-to-net adjustments occur when the assumed discounts and refunds that were estimated to be granted to bigger, typically US government payers at the start of the period were lower than were expected and are, unlike generic price deflation sporadic, unpredictable and unlikely to be repeated next quarter. J&J's upward guidance revision therefore seems quite fragile since it incorporates the effect of last quarter's one-off gross-to-net revision, a lower quarterly tax rate and the absence of Remicade (infliximab) biosimilar competition.

In the opening salvos of second-quarter earnings season the life science sector seems to have gotten off lightly with the absence of any material Brexit effect and a delay to both small molecule and biosimilar competition. In those respects, it is just too early to make a judgement on the sector's quarter or year yet. One hard conclusion I did take away from last week concerned the nearly 7% share price rise on the announcement of Biogen, Inc's. second-quarter results. Most of Biogen's products saw quarterly sales increases. However, the cognoscenti know that most of those increases were due to the two price increases that Biogen has imposed so far this year. I prefer the explanation that after a mixed tenure, investors were happy to see the back of its CEO whose retirement was announced along with Biogen's results. (Also see "Scangos Leaves Biogen Transformed And Transitioning" - Scrip, 21 Jul, 2016.)

Andy Smith is chief investment officer of Mann Bioinvest. Mann Bioinvest is the investment adviser for the Magna BioPharma Income fund which has no position in the stocks mentioned, unless stated above. Dr Smith gives an investment fund manager's view on life science companies. He has been lead fund manager for four life science–specific funds, including International Biotechnology Trust and the AXA Framlington Biotech Fund, and was awarded the Technology Fund Manager of the year for 2007.