The drug and biotech sector has bounced back in the second half of 2022 from a rather weak performance in the first half. An uptick in M&A deals, strong earnings performance, new drug approvals, a favorable regulatory environment and pipeline successes have helped the second-half turnaround. While the broader market has grappled with rising interest rates and inflation, drugmakers have regularly announced positive clinical data and regulatory updates. Meanwhile fears of an upcoming recession in the United States have made drug/biotech stocks attractive to investors who find them safer in uncertain times. Drug/biotech companies are also likely to see significant advances in innovation in 2023. Among the large drugmakers,

Johnson & Johnson


JNJ

,

Novo Nordisk


NVO

,

Merck


MRK

and

AstraZeneca


AZN

are worth retaining in your portfolio.

Industry Description

The Zacks

Large Cap Pharmaceuticals

industry comprises some of the largest global companies that develop multi-million dollar drugs for a broad range of therapeutic areas like neuroscience, cardiovascular and metabolism, rare diseases, immunology, and oncology. Some of these also make vaccines, animal health, medical devices, and consumer-related healthcare products. All these players invest millions of dollars in their product pipelines and line extensions of their already-marketed drugs. Continuous innovation is a defining characteristic of pharma companies and the large drugmakers are constantly investing in drug development and the discovery of new medicines. Regular mergers & acquisitions and collaboration deals are the other key features of large-drug companies.

What’s Shaping the Future of the Large-Cap Pharma Industry?

Innovation and Pipeline Success:


For big drugmakers, innovation in their pipeline is a competitive necessity and key to top-line growth. Pharma companies are constantly striving to ramp up innovation and spending a significant portion of their revenues on R&D.  Successful innovation and product line extensions in important therapeutic areas and strong clinical study results may act as important catalysts for these stocks.

Aggressive M&A & Collaboration Activity:


The sector is characterized by aggressive M&A activity. Given that it takes several years and millions ofdollars to develop new therapeutics from scratch, large pharmaceutical companies sitting on huge piles of cash regularly buy innovative small/mid-cap biotech companies to build out their pipelines. Also, sloppy sales of mature drugs, dwindling in-house pipelines, government scrutiny of drug prices, and the emergence of big tech firms like Apple and Google in the healthcare industry whet the M&A appetite of large drugmakers.Fast-growing and lucrative markets such as oncology and cell and gene therapy are likely to remain focus areas for M&A activities. Also, collaborations and partnerships with smaller companies are in full swing.With target valuations dropping to historic lows, big pharma players used the opportunity for large-scale M&A this year. The latest in the list and also the largest deal of the year was Amgen’s announcement to buy Horizon Therapeutics earlier this week.

Pipeline Setbacks & Other Headwinds:


The failure of key pipeline candidates in pivotal studies and regulatory and pipeline delays can be setbacks for large drug companies and significantly hurt their share prices. Other headwinds for the industry include pricing and competitive pressure, generic competition for blockbuster treatments and a slowdown in sales of some of the most high-profile older drugs.

Foreign exchange headwinds, with the strengthening of the U.S. dollar, increasing interest rates, persistently high inflation, supply chain pressure and the war in Europe are creating an uncertain macro environment and economic volatility.

Uncertainty Surrounding the Pandemic


: The pandemic hurt demand trends of physician-administered drugs of most companies. Though trends recovered in 2021, infection rates shot up significantly in the last quarter of 2021, with the rapid spread of the Omicron variant. In 2022, major waves of variants of concern emerged quickly, became dominant and were superseded by the next variant. There is still uncertainty about the duration and contemplated impact of the pandemic on companies’ results and outlook.

Zacks Industry Rank Indicates Bright Prospects

The Zacks Large Cap Pharmaceuticals industry is a 12-stock group within the broader

Medical

sector.  The group’s

Zacks Industry Rank

is basically the average of the Zacks Rank of all the member stocks.

The Zacks Large Cap Pharmaceuticals industry currently carries a Zacks Industry Rank #83, which places it in the top 33% of around 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Before we present a few large drug stocks that are well-positioned to outperform the market based on a strong earnings outlook, let’s take a look at the industry’s performance and its current valuation.

Industry Versus S&P 500 & Sector

The industry has outperformed the S&P 500 as well as the Zacks Medical Sector this year so far.

Stocks in this industry have collectively risen 12.0% this year so far against the Zacks S&P 500 composite’s decline of 17.6% and the Zacks Medical Sector’s decline of 16.9% in the said time frame.

Year-to-Date Price Performance

Industry’s Current Valuation

Based on the forward 12-month price-to-earnings (P/E), a commonly used multiple for valuing large pharma companies, the industry is currently trading at 16.99X compared with the S&P 500’s 17.72X and the Zacks Medical Sector’s 22.82X.

Over the last five years, the industry has traded as high as 16.99X, as low as 13.31X and at a median of 14.83X as the chart below shows.

Forward 12-Month Price-to-Earnings (P/E) Ratio

4 Large Drugmakers to Keep an Eye On

Merck

: Merck boasts more than six blockbuster drugs in its portfolio, with PD-L1 inhibitor, Keytruda, approved for several types of cancer, alone accounting for around 40% of the company’s pharmaceutical sales. An ongoing recovery from the disruptions related to the pandemic and strong global underlying demand across its business, particularly for Keytruda and Gardasil vaccines to prevent HPV-related cancers, are improving Merck’s sales performance.

Keytruda is continuously growing and expanding into new indications and markets globally. With continued label expansion into new indications and early-stage settings, Keytruda is expected to remain a key top-line driver. Merck’s Animal Health business has been a key contributor to its top-line growth, with the company recording above-market growth. The trend is expected to continue in 2023. Merck boasts a strong cancer pipeline, including Keytruda, which should help drive long-term growth.

Merck’s stock has risen 44.7% this year so far. The Zacks Consensus Estimate for 2022 has risen from $7.31 per share to $7.38 per share while that for 2023 has gone up from $7.21 per share to $7.34 per share over the past 60 days. Merck has a Zacks Rank #3 (Hold).

You can see

the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here

.

Price and Consensus: MRK

J&J

: Johnson & Johnson’s biggest strength is its diversified business model. It operates through pharmaceuticals, medical devices and consumer products divisions. It comprises some 250 subsidiaries, which clearly means that the business is extremely well diversified. Its diversification helps it to withstand economic cycles more effectively.

J&J’s Pharma unit is performing at above-market levels, supported by blockbuster drugs, Darzalex and Stelara, and contributions from newer drugs, Erleada and Tremfya. J&J continues to expect its Pharmaceutical business to deliver market-leading adjusted operational sales growth in 2023 despite the Stelara loss of exclusivity in the second half in the United States.

Sales in the MedTech unit are recovering and the company is focusing on growing this business through new products. J&J is making rapid progress with its pipeline and line extensions. J&J has taken meaningful steps to resolve its talc and opioid litigation

J&J has a Zacks Rank of 3. The Zacks Consensus Estimate for 2022 has risen from $10.01 per share to $10.04 per share over the past 60 days. The stock has risen 4.7% this year so far.

Price and Consensus: JNJ

Novo Nordisk

: Novo Nordisk has one of the broadest diabetes portfolios in the industry. Promising diabetes drug, Ozempic, a once-weekly injectable form of semaglutide, is generating strong sales since its launch and remains the growth engine for the company. Rybelsus, a daily oral formulation of semaglutide, is also witnessing a strong uptake. The FDA has also approved semaglutide as a weekly 2.4-mg injection for weight management in people living with obesity, under the brand name Wegovy. Other drugs like Xultophy and Saxenda are also gaining momentum. Label expansion of these existing drugs is expected to further boost sales.

The Zacks Consensus Estimate for 2022 has declined from $3.27 per share to $3.23 per share while that for 2023 has gone down from $4.01 per share to $3.96 per share over the past 60 days.

Novo Nordisk is a #3 Ranked stock. This Danish drugmaker’s stock has risen 18.6% this year so far.

Price and Consensus: NVO

AstraZeneca:

AstraZeneca’s key drugs, mainly cancer medicines, Lynparza, Tagrisso and Imfinzi should keep driving revenues. Its pipeline is strong with several phase III data readouts lined up. It has also been engaged in external acquisitions and strategic collaborations to boost its pipeline while investing in geographic areas of high growth like emerging markets. Cost-cutting efforts should drive earnings. The Alexion buyout strengthens its immunology franchise, adding several drugs that are boosting its top line.

AstraZeneca has a Zacks Rank #3. The Zacks Consensus Estimate for this British drugmaker’s 2022 EPS has risen from $3.32 to $3.36 per share while that for 2023 has increased from $3.63 to $3.66 per share over the past 60 days. The stock has risen 19.4% this year so far.

Price and Consensus: AZN

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