Generic scheme strikes big pharma
Quebec’s move to introduce a tendering system for generic drugs dragged down the share price of Loblaw Cos. and Jean Coutu Group Inc., as investors fret over how the proposed change will eat into company profits and affect the broader regulatory outlook.
Exactly how much the Quebec proposal will affect Loblaw and Jean Coutu, both of which have divisions that produce generic drugs, remains to be seen — but analysts are not taking any chances. Loblaw’s shares have fallen four per cent since Quebec’s Bill 81 was introduced last week and Jean Coutu’s have fallen 15 per cent.
“It is not possible to predict the outcome and timing of proposed health care reforms in Quebec,” Keith Howlett, analyst at Desjardins Securities, wrote in a note to clients. Lowering drug costs has been a matter of intense provincial debate since the issue first surfaced in Ontario in 2006, he noted.
“Governments are focused on reducing health care costs while simultaneously encouraging a competitive and innovative patientfocused and aligned private healthcare industry,” Howlett said.
“The draft legislation introduced in Quebec this week would, if implemented, likely compress profitability of generic drug manufacturers. The impact would be greatest, in our view, on smaller legal manufacturers such as (Jean Coutu’s) Pro Doc,” Howlett said.
Under the proposed Quebec changes, the province would introduce a tendering system to determine which drug makers will be exclusive suppliers for individual medications. The goal of the bidding process is to lower the price of generics from the current government-set rate, which is roughly 25 per cent of the branded drug’s cost, Howlett said.
Quebec is the fourth province to attempt to implement a bidding system on generics. British Columbia launched tenders for seven drugs earlier this year. Saskatchewan and Ontario tried introducing tenders years ago, but subsequently scrapped them. Alberta intended to lower generic prices to 18 per cent of the cost of branded drugs, but abandoned the initiative. “The short answer for the abandonments, in our view, was driven largely by drug shortages — an unintended consequence of culling generic suppliers,” says David Hartley, analyst at Crédit Suisse.
Howlett suspects generic drug pricing in Quebec could be headed even lower. He maintained a hold rating on Jean Coutu’s stock and lowered his price target to $21 from $23. He maintained his $76 target price buy rating on Loblaw, a much more diverse business by virtue of its grocery division, but noted the retailer may feel the ripple of any potential generic drug pricing changes in Quebec.
“As the largest pharmacy retailer, Loblaw will likely be negatively af- fected if Quebec succeeds in lowering generic drug prices, and if other provinces follow Quebec’s lead,” he said.
David Hartley, analyst at Crédit Suisse, believes Loblaw investors might have overreacted to the drug reform news, which stands to make much more of an impact on Jean Coutu’s bottom line.
“The market appears to be pricing in a roughly 130 per cent hit to (Loblaw’s) Sanis profits in Quebec, suggesting the stock reaction for Loblaw was overdone, versus 47 per cent for Jean Coutu implied by Jean Coutu’s share price movements,” Hartley wrote in a note to clients.
He estimates that Shoppers Drug Mart’s Sanis supplies the retailer’s Pharmaprix franchisees in Quebec with about 50 per cent of its generic drug requirements, compared with 80 per cent to 90 per cent for Jean Coutu and Pro Doc. “The $3 decline in the share price suggests the market believes Jean Coutu’s operating income before amortization of $93 million will be cut by 47 per cent by Bill 81.”
Hartley rates Loblaw at outperform with a target price of $80. He upgraded his rating on Jean Coutu to neutral from underperform because its price has pulled back toward his $17.50 target on the stock, adding the stock is trading below its ten-year price to earnings average.