The inelastic demand for medicines is the primary reason pharma and biotech stocks usually outperform other industries in a recessionary market. Other areas of healthcare don’t do as well. Discretionary services like dental clinics and hospitals suffer as consumers postpone care to save money. Consumers will give up dinners out and vacations, too, before they give up their medication. Does this mean biotech and big pharma stocks can recession proof your portfolio if we go into a recession?
The brief recession caused by the coronavirus in early 2020 did impact big pharma briefly but they bounced back quickly to their original value pre-pandemic. The longer, Great Recession, in 2008 and early 2009 showed no clear effect on quarterly sales or net income for most big pharma. Even in a significantly longer recession big pharma held steady. This durability drills down to the fact that people don’t choose when they get sick, so they don’t choose when they need to buy medication. They end up buying it even in the middle of a recession.
Big Pharma Critical Issues
Investors are flocking to pharma stocks due to their historical ability to weather recessions well. The NYSE Arca Pharmaceutical Index has gained 9% over the past year versus a 13.1% decline for the S&P 500. Pharma stocks trade at about 14.6 times forward earnings compared to the S&P 500’s 16.1 times according to FactSet. The difference is attributed to the S&P’s heavy tech weighting. All good, right?
Pharma is known for paying out above average dividends. Rising interest rates erode the relative value of dividend payments so how well pharma stocks continue to do depend on whether industry leaders can convince the market they can grow earnings. Drugs going off patent could be a problem for earnings growth. Out of pharma’s $900 billion in 2021 revenue about $230 billon will lose patent protection between 2025 and 2030. The good news is pharma has at least $700 billion for deals – deals needed to buy new companies creating new drugs.
Another area of concern is drug-pricing legislation being negotiated in Washington. It does look like a drug-price bill will pass as part of a broader package, possibly representing a revenue hit for the industry. Companies reliant on a single product will be hit harder than better diversified firms.
Biotechs have always excited the capital markets. Those firms seeing success in their clinical trials will experience corresponding success in their share prices. If the biotech company isn’t on the brink of commercializing one of its drugs, raising capital will become much more difficult in a recession. Fewer biotechs will go public or the initial public offering will be much smaller than in the last few years. Big Pharma will be conserving cash to reinforce earnings reports so acquisition activity will go down, too.
Rising interest rates and more conservative lending policies by financial institutions in a recession will make taking on new debt significantly more expensive than it is now. Burning through their cash before commercialization of their product could become a significant problem.