Warren Buffett states, “Uncertainty is the friend of the buyer of long-term values,” and Washington represents a big question mark these days for the pharmaceutical sector.
After all, news broke on Friday that Bristol Myers Squibb
BMY
has sued Uncle Sam over a Medicare price renegotiation program in the Inflation Reduction Act (IRA) that was passed last August. The pharmaceutical giant’s litigation comes on the heels of similar action from rival Merck & Co.
MRK
, which called the program a “sham” and “extortion.”
Bristol Myers and Merck b0th contend that the law violates the Constitution, with the latter stating it “involves neither genuine negotiations nor real agreements.” Rather, Merck argued, “Once [Health and Human Services] unilaterally selects a drug for inclusion in the program, its manufacturer is compelled to sign an ‘agreement’ promising to sell the drug to Medicare beneficiaries at whatever ‘fair’ price the agency dictates, which must represent at least a 25% to 60% discount. If a manufacturer refuses to participate in this ‘negotiation’ or declines to ‘agree’ to sell at the mandated price, it incurs a ruinous daily excise tax amounting to multiples of the drug’s daily revenues. And once the Government successfully coerces entry into such an ‘agreement,’ that manufacturer becomes legally compelled to sell its most valuable products for a fraction of their value, on pain of yet more draconian penalties.”
Just days after the Merck filing in the District of Columbia, the U.S. Chamber of Commerce filed its own lawsuit against the government in the Southern District of Ohio on grounds that the IRA’s program violated the Constitution’s limit on excessive fines by the government along with due-process protections that might afford companies the opportunity to seek judicial or administrative review of certain government decisions.
POLITICAL HOT POTATO
I acknowledge that drug prices in the U.S. are high and a large third-party buyer should be able to use its purchasing power to negotiate discounts for customers’ best interests. At the same time, I think there are legitimate concerns that such efforts to control prices could adversely impact the level of research and development of lifesaving and life-improving medications.
Far too many compounds don’t pan out, while patent cliffs and the threat of biosimilars often awaits blockbusters. I might also wonder if we would still be in the middle of the pandemic without Merck, Pfizer, Moderna, Johnson & Johnson
JNJ
, Gilead Sciences
GILD
and others developing vaccines and therapeutics.
Obviously, drug pricing is a political hot potato and the interplay between the companies in which I invest and Washington is not without consequence, but I always endeavor to make logical and unemotional investment decisions.
I can’t ignore that the new law extends beyond Merck and Bristol Myers to many other major pharmaceutical companies, with the initial drug price reduction process set to begin in September when Uncle Sam identifies the 10 most costly drugs. Following “negotiations,” the new pricing would go into effect in 2026.
However, as the Oracle of Omaha points out, also points out, “You pay a very high price in the stock market for a cheery consensus,” while I am old enough to remember the fantastic returns afforded stocks like MRK following the collapse of the Clinton Administration’s Heath Security Act of 1993 and its attempt to control drug pricing.
MERCK SHARES ARE UNDERVALUED
As Reuters pointed out, “Merck’s top-selling drug, cancer immunotherapy Keytruda, could be subject to negotiations as soon as 2028. Last year, Keytruda sales topped $20 billion – more than a third of Merck’s total sales – and are expected top $30 billion in 2026, according to analyst estimates.”
Effects from the IRA and the approach of Keytruda’s loss of exclusivity in 2028 have likely kept a lid on MRK shares, which are down a smidge year to date. But management said at the release of Q1 financial results that it thinks it could add $10 billion of revenue from just cardiology alone over the next decade. And Keytruda’s life could extend well beyond 2028 with potential methods of delivery on the horizon and combination treatments under investigation, as I note the collaborative effort with Moderna to deliver a Personalized Cancer Vaccine alongside Keytruda.
I continue to think MRK offers growth potential at a reasonable valuation (the NTM P/E multiple is 15), given a deep pipeline and room to add to existing franchises. The consensus analyst corporate profit estimate stands at $6.98 this year, $8.50 in 2024 and $9.64 in 2025. The company boasts a history of returning cash to shareholders, a diversified revenue stream and solid free-cash-flow generation. The dividend yield is 2.7% and my Target Price is $130.
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