Cliff? What Cliff? Pharma Excels Despite Patent Expiries

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It seems three of the most pressing financial “cliffs” that affect various sectors of the economy have been averted. In recent weeks, the fiscal and container cliffs have garnered the most attention, but there was another one looming before them that threatened the well being of pharmaceutical companies.

Called the patent cliff, this crisis boils down to there being more drugs with expiring patents than there are new drugs entering the market. The crisis has led to drug manufacturers losing billions of dollars in sales. Over the next 10 years, the amount of revenue loss due to patent expirations could reach $300 billion.

The industry took the biggest hit last year when an estimated $52 billion worth of patents expired worldwide, according to Fitch Ratings. This year the rating agency says the amount expiring is expected to be in the neighborhood of about $25 billion. And even though the amount of sales lost is expected to be lower this year, pharmaceutical and biotech companies are still under pressure. Fitch recently changed the outlook for the pharmaceutical sector to stable from negative.

We’re seeing generic drug makers eagerly rushing into the pharmaceutical market with cheaper drugs to replace the blockbuster, and often expensive, drugs that are going off patent.

The situation has truly become a matter of the survival of the fittest for the industry.  There are a variety of factors that will be key to the survival of the companies operating in the space. They include their research and development efforts to replenish their pipelines, their willingness to forge relationships with other companies through mergers and acquisitions, and their ability to control costs while taking these steps.

Using the above factors, I reviewed some of the companies that will fare the best in the coming years. I was pleasantly surprised that most were already employing strategies to not only survive, but also to triumph.

Take Eli Lilly (NYSE: LLY), for example. Last week, the company announced that it expects its 2013 revenue to be between $22.6 billion and $23.4 billion. This is despite the expiration of the patent for its hugely successful Cymbalta drug, which is primarily used to treat depression and anxiety. Its patent expires in the fourth quarter of this year.

The saving grace for Eli Lilly comes in the form of revenue growth from several other products in its portfolio. They include the erectile dysfunction drug Cialis and the underarm testosterone treatment drug Axiron. Eli Lilly touts Axiron as the first of its kind because it is applied in the arm pit.

Eli Lilly notes that its operating expenses are expected to be flat to slightly decreasing this year compared to last year. Its R&D expenses should be between $5.2 billion and $5.5 billion. Efforts so far have resulted in 13 potential new medicines that are currently in testing phases.

It expects its gross margin to be about 78%. This margin is in line with some of Eli Lilly’s peers. For example, Pfizer (NYSE: PFE) has a gross margin of about 81%. Its Lipitor drug to treat people with high cholesterol pulled in $10 billion in sales a year before its patent expired.

Like most other pharmaceutical companies worth their salt, Pfizer wasted little time researching and developing new products. Last week, it announced that it and EMD Serono had received approval from the U.S. Food and Drug Administration for a drug to treat multiple sclerosis.

Pfizer has also taken steps to shed businesses that were not crucial to its financial bottom line. That includes selling its nutrition business to Nestle. The deal, which was roughly $12 billion, closed in December.

This should help Pfizer focus on one of its most important segments, and that is in the area of oncology. All eyes are on one of the company’s latest drug called PD 0332991.  The experimental drug is touted as being able to slow the progression of an incurable for of breast cancer.

Now I’ll turn your attention to Merck, which saw its overall sales slump thanks to the patent expirations of Singulair and Remicade.

Not to be thwarted by the patent cliff, Merck (NYSE: MRK) has several significant drugs in its pipeline. It has introduced two diabetes drugs – Januvia and Janumet, as well as a cancer fighting treatment called Vintafolide. There is also an osteoporosis drug called odanacatib. I am most impressed with a new drug to help people with insomnia. Called Suvorexant, the sleep aid is being hailed as the first of its kind. Merck notes that the drug targets certain hormones in the brain that keep you awake. It blocks them, and helps people fall asleep and stay asleep.

A looming concern with Merck stems from lawsuits over Vytorin and Zetia, which have been blockbusters in the company’s pipeline. Generic drug makers Teva Pharmaceutical (NYSE: TEVA) and Impax Laboratories are suing Merck, alleging that the patents are not valid. As noted by Fool Writer Brian Orelli, these suits are troublesome because they involve Merck’s third and fifth best-selling drugs, respectively. Furthermore, they could soon move up as Singulair sales fade, Orelli said.

Compared to the gross margins of Eli Lilly and Pfizer, Merck’s is the lowest at 63.99%.

Later this month, we’ll get a better idea about how the patent cliff impacted these drug manufacturers during the fourth quarter, as well as all of 2012. That’s because all of them will be releasing their earnings reports.

TwillyD has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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