Morningstar Advisor - August/September 2010 - 34

Spotlight

AstraZeneca, GlaxoSmithKline, and Pfizer. Sanofi has the top market share in emerging markets, and we expect the company’s strong historical entrenchment to enable it to maintain this position for several years. The company was among the first to enter Russia (in 1970) and China (in 1982), as well as several other markets. In emerging markets, brand awareness is critical, and Sanofi’s long history in these territories has helped instill a strong brand name, creating a significant competitive advantage. Further, we expect that Sanofi will maintain its acquisition strategy in emerging markets and continue to build its presence. Despite being the drug leader in emerging markets, Sanofi has room to grow. It only has 6% market share, which shows how fragmented these markets are. At 22% annually from 2004 to 2009, AstraZeneca is expanding its emerging-markets base faster than any other drug firm. AstraZeneca has laid out a three-pronged attack for continued growth: It plans to expand in Brazil, Russia, India, China, Mexico, and Turkey; target smaller emerging markets; and develop more branded generics. We believe that the company’s broad strategy will yield solid results, and we project that 24% of Astra’s sales will come from emerging markets by 2014. Like Sanofi, Glaxo is well positioned for enlarging its emerging-markets platform. Its portfolio of over-the-counter drugs, vaccines, branded drugs, and some generic drugs and diabetes treatments puts Glaxo in all of the key emerging-markets growth segments. We project that the company will increase sales in emerging markets at a 10% annual rate from 2009 to 2014. Acquisitions have the potential to increase that number. While Pfizer’s growth has lagged behind some of its rivals during the past five years, the company has the second-best market share in emerging markets. We expect that Pfizer is in a unique position to accelerate its growth

Our Top Picks in Pharmaceuticals
Morningstar Rating for Stocks Fair Value Estimate Economic Moat Fair Value Uncertainty Price/Fair Value

AstraZeneca AZN GlaxoSmithKline GSK Novartis NVS Pfizer/Wyeth PFE Sanofi SNY

QQQ QQQQ QQQQQ QQQQQ QQQQQ

$53.00 $47.00 $71.00 $26.00 $46.00

Wide Wide Wide Wide Wide

Medium Medium Low Medium Medium

0.92 0.74 0.70 0.57 0.66

Fair Value Uncertainty rates how much confidence our analysts have in their Fair Value Estimate for a company. The greater level of uncertainty, the greater the discount to fair value required before a stock can earn 5 stars. Price/Fair Value divides the stock price by our Fair Value Estimate. Companies with a ratio less than 1 are undervalued. Data as of July 9, 2010

rate because of the launch of several new products. We think that sales of products gained from Pfizer’s acquisition of Wyeth will see an uptick as they hook into Pfizer’s powerful emerging-markets distribution network. Further, several key products for Pfizer have not yet launched in important emerging markets; Lyrica and Enbrel have not launched into China, for example. These two drugs, especially Lyrica, should provide Pfizer a windfall there, and China is the most important emerging market.
What It All Means

The market overreacted to the passage of health-care reform, bashing pharmaceutical stocks when the initial costs of reform began showing up on balance sheets and projections. What the market is failing to consider is that, by the end of this decade, reform will actually add to pharma’s earnings. The market is also undervaluing two industrytransforming trends: a focus on developing niche drugs and a move into emerging markets. At first glance, orphan drugs appear to have limited sales potential. But many of these candidates will have strong pricing power and see their markets grow as they effectively treat their target diseases and are found to work against other diseases as well. We expect that big pharma’s valuations will expand as these niche drugs generate higher-than-expected sales and the market

increases its value of big-pharma pipelines. The market is also discounting the significant upside that emerging markets offer drug companies. Pharma analysts have a tradition of focusing on developed markets in their forecasts and of regarding emerging markets as too weak to matter. Investors also have the mistaken perception that margins are too low, and because few firms report specific emerging-markets sales data, investors don’t have a clear understanding of sales growth in these areas. We see things differently. As emerging markets become richer, people will buy more drugs, creating a strong tailwind for the entire drug industry. As emergingmarkets sales grow, we believe that the market will realize its mistake. Investors have the chance now to capitalize before it does. K
Damien Conover, CFA, is Morningstar’s pharmaceuticals equities strategist and editor of Morningstar Healthcare Observer.

34 Morningstar Advisor August/September 2010

Morningstar Advisor - August/September 2010

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