Morningstar Advisor - August/September 2010 - 31

launch of Tasigna, which actually works better than Gleevec. We expect this strategy to play out again with the company’s late-stage pipeline drug SOM230, which should be a successful follow-up to Sandostatin. Glaxo and Pfizer are building their orphan-drug pipelines. In February, Glaxo launched a new orphan-drug specialist unit to research and develop new drugs for rare diseases. Glaxo already has a success story in Promacta for ITP and chronic lymphocytic leukemia. In 2009, Glaxo was also active in signing deals with other companies to license new orphan-drug candidates. Pfizer, meanwhile, signed a deal in 2009 with Protalix to develop an enzyme replacement therapy for the treatment of Gaucher disease. Other big-pharma firms are in the mix, too, including Bristol-Myers Squibb and Merck with their cancer therapies Sprycel and Temodar, respectively. Given the potential for high rewards and portfolio diversification, we expect other large drug companies will increase their efforts to develop orphan drugs.
Emerging Opportunities

Where Pharma Will Get Its Growth
Revenue 2003–09 Growth Rate in Emerging Countries Five-Year Projected Growth Rate in Emerging Countries Five-Year Projected Growth Rate in Developed Countries Emerging-Markets Contribution 2009 Sales 2014E Sales Contribution to Growth

Abbott Laboratories ABT* AstraZeneca AZN Bristol-Myers BMY Eli Lilly LLY GlaxoSmithKline GSK** Johnson & Johnson JNJ* Merck/Schering MRK Novartis NVS Pfizer/Wyeth PFE Sanofi SNY
Average
*Pharma sales only.

15% 22% 15% 10% 11% 15% 10% 15% 8% 19%
14%

13% 20% 10% 8% 10% 12% 8% 13% 9% 12%
12%

7% –7% 0% –1% 0% 1% 2% 4% –2% –8%
1%

9% 8% 8% 6% 10% 8% 9% 14% 8% 25%
11%

12% 24% 12% 9% 15% 13% 12% 20% 13% 47%
18%

Some All All All All Majority Majority Some All All

**Does not include over-the-counter products. Data as of June 30, 2010. Source: IMS, company reports, and Morningstar.

In the past, developing countries were not good markets for branded drugs. Incomes were too low to pay for drugs, and law enforcement turned a blind eye to counterfeiting, which was rampant. But fast-growing economies, strong-enough pricing margins, and a perception that brands signify quality have created very important new markets for the drug industry. These new markets represent a paradigm shift for the investment community, which has long viewed the United States, Western Europe, and Japan as the major pharmaceutical markets in the world. But like niche drugs, emerging markets offer tremendous upside for drug companies—something the market is not fully appreciating. Growth in GDP is directly correlated with drug spending. Based on a sample of 63 emerging and developed countries, World Markets

Monitor calculated an 80% correlation between per capita GDP and pharmaceutical spending. The rapid growth in emergingmarkets incomes during the past five years has led to dramatically higher drug purchases. From 2004 to 2009, the BRIC (Brazil, Russia, India, and China) population with household incomes above $5,000 grew by 27% annually. While this growth is expected to slow from 2009 to 2014, 16% annual growth is still forecast. This massive expansion in wealth should directly increase the market opportunity for drug companies. Historical data on drug spending in emerging markets can be sketchy, but estimates from IMS Health put spending growth at 14% annually over the past five years to represent 11% of big pharma’s total sales in 2009. AstraZeneca AZN and Sanofi SNY led the pack with 22% and 19%, respectively, compound annual growth in emerging markets during the past five years. Even on the low side, Pfizer posted a respectable 8% growth during that period.

For the next five years, we project that drug-sales growth in emerging markets will average 12% annually; we think that the slowdown in income growth will cause drug spending growth to decelerate. Still, this lower growth rate far exceeds that of developed countries, where we expect only 1% annual sales growth through 2014. We estimate that sales from emerging markets will represent about 18% of big pharma’s total sales by 2014. With higher growth rates come lower, but still attractive, operating margins. Emerging markets offer operating margins at a 31% discount when compared with developedmarkets’ margins. (Drug companies see a 50% profit margin in developed countries versus 34.5% in emerging markets.) Given the robust margins in developed countries, a 31% discount still brings strong profitability. Although pricing power varies depending on the therapeutic class and market, branded drugs in emerging markets are typically priced 50% cheaper than those in developed markets. Operating costs, however, are much

MorningstarAdvisor.com 31


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Morningstar Advisor - August/September 2010

Table of Contents for the Digital Edition of Morningstar Advisor - August/September 2010

Morningstar Advisor - August/September 2010
Contents
New on MorningstarAdvisor.com
Contributors
Letter From the Editor
What Aspects of Health-Care Reform Will Most Affect Your Clients?
Bonds, Chicago Style
Investment Briefs
Which Risk Are You Managing?
Eye on the Prize
Advisors Can’t Rely on Fidelity Alone
Health Care Gets Back to Business
An Opportune Time to Bet the Pharm
Reform’s Impact on Other Health-Care Industries
Top Takeover Targets in Biotech
After Reform, Narrow-Moat Firms Have Strong Prospects in Diagnostics
Health-Care Investing Alive and Well
Quest for Knowledge
Four Picks for the Present
How to Make Your Bond Portfolio Inflation-Resistant
Weeding Through the Energy Patch
Uncertainty and Value in Basic Materials
Stock Market Doom-Busters
Hunting Down European Debt-Dodgers
Mutual Fund Analyst Picks
50 Most Popular Equity ETFs
Undervalued Stocks With Wide Moats
VA Sales Slip a Bit in First Quarter
New at Morningstar
Star Wars, the Sequel
Morningstar Advisor - August/September 2010 - Morningstar Advisor - August/September 2010
Morningstar Advisor - August/September 2010 - Cover2
Morningstar Advisor - August/September 2010 - 1
Morningstar Advisor - August/September 2010 - 2
Morningstar Advisor - August/September 2010 - Contents
Morningstar Advisor - August/September 2010 - 4
Morningstar Advisor - August/September 2010 - 5
Morningstar Advisor - August/September 2010 - New on MorningstarAdvisor.com
Morningstar Advisor - August/September 2010 - 7
Morningstar Advisor - August/September 2010 - Contributors
Morningstar Advisor - August/September 2010 - Letter From the Editor
Morningstar Advisor - August/September 2010 - What Aspects of Health-Care Reform Will Most Affect Your Clients?
Morningstar Advisor - August/September 2010 - 11
Morningstar Advisor - August/September 2010 - Bonds, Chicago Style
Morningstar Advisor - August/September 2010 - 13
Morningstar Advisor - August/September 2010 - Investment Briefs
Morningstar Advisor - August/September 2010 - 15
Morningstar Advisor - August/September 2010 - Which Risk Are You Managing?
Morningstar Advisor - August/September 2010 - 17
Morningstar Advisor - August/September 2010 - 18
Morningstar Advisor - August/September 2010 - Eye on the Prize
Morningstar Advisor - August/September 2010 - 20
Morningstar Advisor - August/September 2010 - 21
Morningstar Advisor - August/September 2010 - Advisors Can’t Rely on Fidelity Alone
Morningstar Advisor - August/September 2010 - 23
Morningstar Advisor - August/September 2010 - 24
Morningstar Advisor - August/September 2010 - 25
Morningstar Advisor - August/September 2010 - 26
Morningstar Advisor - August/September 2010 - Health Care Gets Back to Business
Morningstar Advisor - August/September 2010 - An Opportune Time to Bet the Pharm
Morningstar Advisor - August/September 2010 - 29
Morningstar Advisor - August/September 2010 - Reform’s Impact on Other Health-Care Industries
Morningstar Advisor - August/September 2010 - 31
Morningstar Advisor - August/September 2010 - 32
Morningstar Advisor - August/September 2010 - Top Takeover Targets in Biotech
Morningstar Advisor - August/September 2010 - 34
Morningstar Advisor - August/September 2010 - 35
Morningstar Advisor - August/September 2010 - After Reform, Narrow-Moat Firms Have Strong Prospects in Diagnostics
Morningstar Advisor - August/September 2010 - 37
Morningstar Advisor - August/September 2010 - 38
Morningstar Advisor - August/September 2010 - 39
Morningstar Advisor - August/September 2010 - 40
Morningstar Advisor - August/September 2010 - Health-Care Investing Alive and Well
Morningstar Advisor - August/September 2010 - 42
Morningstar Advisor - August/September 2010 - 43
Morningstar Advisor - August/September 2010 - 44
Morningstar Advisor - August/September 2010 - 45
Morningstar Advisor - August/September 2010 - 46
Morningstar Advisor - August/September 2010 - 47
Morningstar Advisor - August/September 2010 - 48
Morningstar Advisor - August/September 2010 - Quest for Knowledge
Morningstar Advisor - August/September 2010 - 50
Morningstar Advisor - August/September 2010 - 51
Morningstar Advisor - August/September 2010 - Four Picks for the Present
Morningstar Advisor - August/September 2010 - 53
Morningstar Advisor - August/September 2010 - How to Make Your Bond Portfolio Inflation-Resistant
Morningstar Advisor - August/September 2010 - 55
Morningstar Advisor - August/September 2010 - 56
Morningstar Advisor - August/September 2010 - 57
Morningstar Advisor - August/September 2010 - Weeding Through the Energy Patch
Morningstar Advisor - August/September 2010 - 59
Morningstar Advisor - August/September 2010 - 60
Morningstar Advisor - August/September 2010 - Uncertainty and Value in Basic Materials
Morningstar Advisor - August/September 2010 - 62
Morningstar Advisor - August/September 2010 - 63
Morningstar Advisor - August/September 2010 - Stock Market Doom-Busters
Morningstar Advisor - August/September 2010 - 65
Morningstar Advisor - August/September 2010 - Hunting Down European Debt-Dodgers
Morningstar Advisor - August/September 2010 - 67
Morningstar Advisor - August/September 2010 - Mutual Fund Analyst Picks
Morningstar Advisor - August/September 2010 - 69
Morningstar Advisor - August/September 2010 - 70
Morningstar Advisor - August/September 2010 - 71
Morningstar Advisor - August/September 2010 - 50 Most Popular Equity ETFs
Morningstar Advisor - August/September 2010 - 73
Morningstar Advisor - August/September 2010 - Undervalued Stocks With Wide Moats
Morningstar Advisor - August/September 2010 - 75
Morningstar Advisor - August/September 2010 - VA Sales Slip a Bit in First Quarter
Morningstar Advisor - August/September 2010 - 77
Morningstar Advisor - August/September 2010 - 78
Morningstar Advisor - August/September 2010 - New at Morningstar
Morningstar Advisor - August/September 2010 - Star Wars, the Sequel
Morningstar Advisor - August/September 2010 - Cover3
Morningstar Advisor - August/September 2010 - Cover4
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