The credit cycle has been extended by central bank policies that enable high corporate borrowing at very low interest rates.
Drug pricing is a significant component of both financial and environmental, social and governance (ESG) analyses of drug companies. In recent years, some drugmakers have faced intense scrutiny for aggressively raising prices on brand-name drugs. In limited cases, these price increases have been more than 100 percent to the consternation of many patients, politicians and social activists.
Pharmaceutical manufacturers have been able to raise branded drug prices because the patents on these drugs make them exclusive in the market. Drug manufacturers reason that high prices are needed to support the research and development costs that lead to new medications. Additionally, when patents on those drugs expire, generics can enter the market and prices can fall precipitously.
It is important to understand how drug prices are determined. Pharmaceutical manufacturers sell drugs to patients through intermediaries. These intermediaries, which include pharmacy benefit managers (PBMs), insurance companies and drug wholesalers, negotiate the list prices before the drugs reach the consumer. In most cases, the pharmaceutical manufacturers do not receive the list price; instead, they receive a net price reduced by rebates and discounts. QuintilesIMS Institute data shows that list prices rose roughly 12 percent in 2015, but estimated net prices increased approximately 3 percent. Nonetheless, headlines about list price increases have led to heavy pressure on the drug industry to respond.
Following consolidation within the industry, PBMs and wholesalers are negotiating more aggressively, which has already started to reduce the net prices earned by manufacturers. PBMs are particularly strong pricing negotiators, and their share of the market has been rising; as of 2016, PBMs managed pharmacy benefits for 266 million Americans.1 Looking forward, the QuintilesIMS Institute estimates that from 2017 to 2021, branded drug prices will increase between 8 percent and 11 percent, while net prices will increase between 2 percent and 5 percent.
A Credit Perspective
From an ESG risk perspective, we view the outcry on pricing and the ethical concerns raised by the public as significant. We are monitoring drug companies’ responses to this issue and various regulators’ concerns about high drug prices. In particular, we are closely following each company’s average net price increases relative to those of its peers when made available. We are also looking carefully at the number of pricing-related allegations and controversies being faced by individual pharmaceutical manufacturers.
Transparency is one important way for companies to respond to this issue, in our view. While we believe that transparent reporting is important for all corporate issuers (see ESG Integration in Corporate Fixed Income), we think it is particularly relevant with regard to drug pricing. Companies that are able to show fair pricing practices are more likely to be able to limit the reputational and litigation risks related to drug pricing.
To that end, many drugmakers have stated plans to be more transparent on drug price increases. For example, earlier this year Merck & Co. Inc. and Johnson & Johnson published transparency reports that provided visibility into their list and net drug price increases over the last five to seven years.
In terms of the financial implications for drug companies, list price increases – even when taking rebates and discounts into account – generally increase the top line for drug manufacturers. Therefore, regulatory changes have a significant impact on drug companies. That said, government approval or timing of any new drug pricing regulation is very uncertain.
Pharmaceutical manufacturers continue to face risks related to uncertain regulatory changes, patent expirations and debt-funded M&A driven by possible cash repatriation policies. Even so, we believe the drug industry is stable from a credit perspective. In general, investment-grade drug companies have strong balance sheets, generate strong free cash flow and provide an essential service. In addition, an aging population should help lift spending on prescription drugs.
While we believe that average list price growth could be moderately lower in the future, overall we do not think this issue will significantly impact the credit profiles of investment-grade pharmaceutical companies.
 The Pharmaceutical Care Management Association (PCMA), as of February 4, 2016.
DISCLAIMER: The material in this document is prepared for our clients and other interested parties and contains the opinions of Breckinridge Capital Advisors. Nothing in this document should be construed or relied upon as legal or financial advice. Any specific securities or portfolio characteristics listed above are for illustrative purposes and example only. They may not reflect actual investments in a client portfolio. All investments involve risk – including loss of principal. An investor should consult with an investment professional before making any investment decisions. This document may contain material directly taken from unaffiliated third party sources, including but not limited to federal and various state & local government documents, official financial reports, academic articles, and other public materials. If third party material is included, it is believed to be accurate, and reliable. However, none of the third party information should be relied upon without independent verification. All information contained in this document is current as of the date(s) indicated, and is subject to change without notice. No assurance can be given that any forward looking statements or estimates will prove accurate or profitable.