Industry experts and investors contend that companies will largely offset the costs of healthcare reform by raising prices on their drugs, and that the recent pressure on stock prices has created a buying opportunity.
The law is frontloaded in terms of its negative impact and the positives play out down the road, said David Katz, fund manager for Matrix Asset Advisors, referring to the tens of millions of paying customers expected to join the insurance rolls in 2014.
We would not look as this as an ongoing problem, but rather as a one-time reset, he said. If you liked these companies before this week, there's no reason not to like them after this week.
Wall Street was aware that reform would carry a price tag, but it was not until calculations were put to paper by Eli Lilly (LLY.N) on Monday that the costs hit home.
Pharmaceutical and biotech companies such as Lilly, Abbott Laboratories (ABT.N) and Amgen Inc (AMGN.O) spelled it out when they reported results, sending shares lower across the sector.
Nobody was talking about this as a major factor before earnings season, said Hapoalim Securities analyst Jon LeCroy. I'm surprised it hadn't been highlighted ahead of Lilly's (report).
While Lilly reported better-than-expected first-quarter earnings, the company said reforms would crimp its 2010 revenue by $350 million to $400 million -- forcing a cut of 35 cents per share from its full-year profit forecast.
For 2011, it expects the reforms to hurt its revenue by up to $700 million, or about 3 percent of the company's sales.
Much of the early cost comes from requirements that drugmakers begin giving bigger price rebates this year to patients in the Medicaid insurance program for the poor.
Costs pick up next year, when companies must also provide 50 percent price discounts to fill a so-called doughnut hole gap in drug coverage in the federal Medicare program for the elderly.
Concern aroused by Lilly intensified as Johnson & Johnson (JNJ.N) and Abbott Laboratories outlined the 2010 sales hit each would take -- $400 million to $500 million for J&J and $230 million for Abbott.
Biotech giants Amgen and Gilead Sciences Inc (GILD.O) this week each also outlined at least a $200 million impact to 2010 sales from healthcare reform.
Merck & Co (MRK.N) said Friday it expects sales to be cut by $170 million this year because of the reforms. The hit next year will be $300 million to $350 million, the company said, which amounts to less than 1 percent of Merck's annual sales are about $46 billion.
Companies with a larger proportion of U.S. sales -- such as Lilly and Bristol-Myers Squibb Co (BMY.N), which reports earnings next week -- are hit harder by the new law.
Some companies with less exposure to federal reimbursement will have it easier, such as Forest Laboratories Inc (FRX.N), whose $30 million 2010 hit is less than 1 percent of sales.
The NYSE Arca Pharmaceutical Index .DRG is down about 2.6 percent this week and the NYSE Arca Biotech Index .BTK is down about 3 percent -- both lagging the broader S&P 500 .SPX,which is up about 1.4 percent.
Some people are selling healthcare right now as they digest the impact of reform. We are seeing a temporary rotation out of the healthcare sector, said RBC Capital Markets biotech analyst Michael Yee after Amgen on Wednesday estimated the new laws would cut about 2 percent of its U.S. sales this year.
Amgen said it expects reform will trim its U.S. sales by 5 percent to 6 percent next year, and predicted its 2010 results will come in toward the low end of its prior forecast range.
But drugmakers will likely offset much of the new costs by raising prices, analysts said.
I wouldn't be surprised to see 8 percent industry-wide price increases this year, said LeCroy, who added that insurers could be expected to pass along the increases in the form of higher premiums.
The cost of the reforms was higher than expected, but not shocking, said Morningstar analyst Damien Conover.
This is actually a pretty moderate plan, he said, compared with government-run health plans in Europe that can impose price controls. In 2014, we should see an inflection point and those negatives start to mitigate.
As we go on from 2014, there will be an upside of as much as 2 percentage points in earnings, he added.
The costs of healthcare reform will be manageable, but will make drug stocks riskier investments, said Tim Nelson, an asset manager with First America Funds.
Growth now is not stellar by any means for the industry, and now we have this kind of headwind that will be multi-year in duration, Nelson said.
Exaggerated concern about the healthcare costs could provide an opportunity to savvy bargain hunters, Conover said.
Large U.S. and European drug stocks, on average, are trading at 10 times expected 2010 per share earnings, about 20 percent less than what they are worth, he said. Over the next two to three years, we'll see the valuations improve.
LeCroy agreed that patience could reward investors, saying that stocks of big drugmakers are trading at a 43 percent discount to the Standard and Poor's 500 index, in contrast to a 50 percent premium to the index in the late 1990's.
People own them because they trade at such a massive discount. And they've gotten cheaper this week.