Health-Care Stocks: The Obama Effect

S&P equity analysts examine the ramifications for the industry of potential policy moves by the new Administration

By Herman Saftlas, Steven Silver, Phillip Seligman, Jeffrey Loo, CFA and Jeffrey Englander, CFA From Standard & Poor's Equity Research

While we believe more pressing general economic issues will take precedence, we still think health-care reform will be a key priority in the Obama Administration. With Democrats now in control of both the White House and Congress, we believe they now have the opportunity to pass meaningful reform legislation to provide health-care insurance coverage for some 46 million uninsured Americans (15% of the total population).

The new coverage, funded to a large extent by the federal government (which most experts estimate will cost between $120 billion and $150 billion, depending upon the scope of the package), would likely expand access to health care and increase revenues for providers of medical products and services, including pharmaceutical companies.

However, the Obama program also calls for significant cost reductions, which we believe would adversely affect the branded pharmaceutical industry in terms of both discounted pricing and contracted use of branded drugs.

Change in Medicare Part D Coming

The key issue, in our opinion, is the planned elimination of the noninterference clause in the Medicare Part D prescription drug program, which funds drug coverage for some 44 million elderly Americans. Under the present system, the government is prohibited from engaging in Medicare drug pricing negotiations with pharmaceutical manufacturers. Negotiations are handled strictly by private-sector managed care and pharmacy benefit management firms.

President-Elect Obama and congressional Democrats favor changing the program to allow or possibly require direct government negotiations with drug manufacturers, which is expected to sharply lower the program's cost. Another likely money-saving tactic will be greater use of inexpensive generics through new incentives.

We have "strong buy" recommendations on Abbott Laboratories (ABT) and Johnson & Johnson (JNJ). We think these companies are well-positioned in growing pharmaceutical, device, and consumer health-care markets. In the domestic pure play pharma segment, we have buys on Bristol-Myers (BMY) and Schering-Plough (SGP). Our recommendations in the generic space are Teva Pharmaceutical Industries (TEVA) and Watson Pharmaceuticals (WPI).

BIOTECH

We have a generally favorable outlook for the biotech sector under the Obama presidency. We see increased funding for the Food & Drug Administration and National Institutes of Health, which should help the FDA stay current on science-related research and approve new drugs on schedule, and allow the NIH to conduct clinical studies and promote innovative research through new grants. In addition, we expect an Obama Administration to support the advancement of embryonic stem-cell research, which may open new avenues to treat serious diseases.

On the negative side, we think Obama will be a staunch supporter of implementing a new regulatory pathway for generic drugs. Competition from generic biotech drugs would put pressure on drug pricing, and lower returns that we believe are necessary for firms to recoup investments and to support pharmaceutical and biotechnology innovation.

We have strong buy recommendations on Genzyme (GENZ) and Celgene (CELG).