Morgan Stanley US drug sector note predicts 'no M&S slowdown'

LONDON (ShareCast) - Morgan Stanley (Xetra: 885836 - news) said it does not foresee an imminent slowdown in deal activity in the drug sector, with spending on research and development also expected to gain approval from the market. In a note examining some of the key investment debates that it sees as shaping the pharma industry for years to come, the bank concluded that, having being punished by the market due to several disappointments in the past decade, mergers and acquisition (M&A) activity was currently being rewarded "and likely will continue to be rewarded for some time".

The trend for M&A among pharmaceutical groups led to an unprecedented $273bn of deals last year, helping the sector's stocks outperformed the S&P 500 by over 600 basis points in the past 12 months.

Morgan Stanley said: "Healthcare typically has an elevated level of M&A, and when M&A accelerates generally in a sector it typically stays high for a while in that sector. In addition, pharma M&A is benefiting from ample access to capital and a typically minimal time before a transaction becomes accretive - cyclical advantages that should support more 'roll-up' activity." Analysts at the bank believe that rewards for M&A will continue in the short-term due to the fragmentation of the industry and the likelihood that consolidation will boost shareholder returns.

However, M&A-driven returns could fall in coming years, they warned, as the number of targets diminishes, drug pricing faces greater scrutiny, and interest rates rise.

But while Morgan said the M&A boom was in its later stages, it does not foresee an imminent M&A slowdown.

The note also predicted that research and development, which has also been punished by the market in recent years, might present an opportunity.

"We believe that R&D intensity will remain in the midteens relative to spending, as industry efficiency initiatives pay off. We thus think that R&D spending is unlikely to be incrementally punished from here." The industry is expected to increase investments in three primary areas in the near term: cancer, central nervous system disorders such as Alzheimer's, and autoimmune diseases such as arthritis.

Also, analysts assessed the pharmaceutical industry on a number of fundamental metrics relative to other industries across the market.

"Despite the strong recent relative stock performance, we think the industry merits further multiple expansion. We expect to retain a positive bias for some time," the note said.

The main current stock recommendations are Actavis (ACT (Frankfurt: 0LW.F - news) ), Endo International (NasdaqGS: ENDP - news) (ENDP), Eli Lilly (LLY) and Valeant Pharmaceuticals (VRX).