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What Lies Ahead for Pharma ETFs in Second Half 2017

We are halfway through 2017 and pharma stocks have recovered nicely with their performance representing a sharp contrast to 2016 when the sector was under immense pressure due to the drug pricing issue. Another factor that weighed on pharma stocks last year was the noticeably lower number of FDA approvals. 2016 saw only 22 treatments gaining FDA approval, well below 45 approvals in 2015 and 41 in 2014. The industry was also hit by some high profile R&D failures as well as mixed results, slower-than-expected new product launches and increasing competition.

 

However, the sector has fared better this yearand the NYSE ARCA Pharmaceutical Index is up 10.1% year-to-date (YTD). New product sales ramp up, R&D success and innovation, strong results, a higher number of FDA approvals and continued strong performance from legacy products are some of the factors that could contribute to a sustained recovery in the sector. Tax reforms and cash repatriation would support a recovery as well. (Read: Forget Big Tech; Biotech ETFs are Soaring Higher)

 

Importantly, investors now seem to be more comfortable with the drug pricing scenario and are willing to look at the fundamentals of the sector. Although the drug pricing issue will remain a headwind this year as well, expectations are that steps taken by the Trump administration to drive down drug prices will not be as draconian as previously expected. 

 

Deregulation and increased competition seem to be some of the ways that will be used to control drug prices. FDA Commissioner Scott Gottlieb recently said that the agency is working on a plan to lower healthcare costs by speeding up the development of next-generation treatments, especially for rare diseases or targeted cancer therapies.

 

Faster Drug Approval Process?

 

At a meeting with pharma majors earlier this year, President Trump spoke about speeding up the FDA approval process. The President said that the FDA will be streamlined and the drug approval process will be much faster. The 21st Century Cures Act is a step in this direction.

 

With the passing of this Act, expectations are that there will be more innovation in the sector and, maybe, a surge in new drug approvals. According to an IMSQuintiles report, the late-phase R&D pipeline for the industry indicates that there should be about 40-45 new brand launches every year through 2021.

 

Meanwhile, the FDA has already surpassed last year’s total tally with 23 drugs being approved so far in 2017.  (Read: How to Build a Winning ETF Portfolio for Second-Half 2017)

 

Will M&As Pick Pace?

 

There has been a lot of consolidation in the pharma industry over the last few years with quite a few deals being announced/completed in 2016. Expectations are high that M&As will increase as the year progresses -- potential tax reform and cash repatriation are expected to lead to a boost in this area. While not too many deals have been announced so far in 2017, we could see several M&A agreements being announced in the coming quarters though companies are wary of bidding wars leading to over-priced deals.

 

Companies with innovative technologies and pipelines are highly sought after. Niche disease areas like nonalcoholic steatohepatitis (NASH), immuno-oncology and multiple sclerosis are in demand. Treatments for orphan diseases are also much sought after with quite a few deals being signed in these areas. (Read: Best Leveraged ETFs of First Half of 2017)

 

Innovative Pipelines & Catalyst Rich 2017

 

Pharma companies continue to work on bringing innovative new treatments to market, and there could be significant catalysts in the coming quarters in the form of important new product approvals as well as major data read-outs especially in key therapeutic areas like immuno-oncology, Alzheimer’s, central nervous system disorders, and immunology/inflammation.

 

Cancer remains a key focus area. According to IMSQuintiles, 68 new cancer drugs were approved for 22 indications from 2011 to 2016 while worldwide costs for cancer therapeutics and supportive care drugs shot up from $91 billion in 2012 to $113 billion in 2016. More than 600 molecules are in late stage development with the majority being targeted therapy.

 

Meanwhile, sales of products that gained approval over the last two years as well as line extensions should ramp up and boost growth.

 

Pharma ETFs in Focus

 

Highlighted below are some pharma ETFs - ETFs present a low-cost and convenient way to get a diversified exposure to the sector.

 

Powershares Dynamic Pharmaceuticals ETF (PJP)

 

PJP, launched in Jun 2005 by Invesco PowerShares, tracks the Dynamic Pharmaceuticals Intellidex Index. The fund covers healthcare stocks. The top 3 holdings include Celgene Corporation (5.24%), Amgen Inc. (5.14%) and AbbVie Inc. (5.01%). The total assets of the fund as of Jul 6, 2017 were $742.1 million representing 30 holdings. The fund’s expense ratio is 0.57% while dividend yield is 0.81%. The trading volume is roughly 53,041 shares per day.

 

SPDR S&P Pharmaceuticals ETF (XPH)

 

XPH, launched inJun 2006, tracks the S&P Pharmaceuticals Select Industry Index. This ETF primarily covers pharma stocks with the top 3 holdings being Akorn, Inc. (5.27%), Jazz Pharmaceuticals plc (5.19%), and Endo International, plc (4.7%).

 

Total assets as of Jul 6, 2017 were $458.5 million representing 38 holdings. The fund’s expense ratio is 0.35% and dividend yield is 0.62%.The trading volume is roughly 58,019 shares per day.

 

iShares U.S. Pharmaceuticals (IHE)

 

IHE, launched in May 2006, seeks investment results that correspond generally to the price and yield performance of the Dow Jones U.S. Select Pharmaceuticals Index. The fund mainly consists of pharma companies (89.8%). Biotech companies account for about 10.1% of the fund.

 

The top 3 holdings of this fund are Johnson & Johnson (9.95%), Pfizer Inc. (8.21%) and Merck & Co. Inc. (7.58%). The total assets of the fund as of Jul 6, 2017 were $693.7 million representing 41 holdings. The fund’s expense ratio is 0.44% with the dividend yield being 1.25%. The trading volume is roughly 19,527 shares per day.

 

Market Vectors Pharmaceutical (PPH)

 

PPH was launched in Dec 2011 and tracks the Market Vectors U.S. Listed Pharmaceutical 25 Index. This ETF covers healthcare stocks. While the expense ratio is 0.35%, dividend yield is 1.95%. The trading volume is roughly 39,357 shares per day. The total assets of the fund as of Jul 6, 2017 were $276.8 million representing 26 holdings. The top 3 holdings of this fund are Johnson & Johnson (8.63%), Novartis AG (6.4%) and AbbVie Inc. (5.17%).

 

Conclusion

 

Although fears regarding the drug pricing issue have waned, it will nevertheless remain a headwind until the Trump administration comes out with a policy for controlling drug prices. Meanwhile, increased pipeline visibility and appropriate utilization of cash should increase confidence in the sector.

 

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PWRSH-DYN PHARM (PJP): ETF Research Reports
 
SPDR-SP PHARMA (XPH): ETF Research Reports
 
VANECK-PHARMA (PPH): ETF Research Reports
 
ISHARS-US PHARM (IHE): ETF Research Reports
 
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