EU pharma: still a call on relative earnings growth, not catalysts
We retain a modestly overweight stance for EU pharmaceuticals based on a cautious
economic outlook as opposed to robust fundamentals or specific catalysts for the sector. Our
2008 Outlook report (19 Dec) argued that the 8-9% earnings growth outlook for EU pharma
2008-12E looked relatively robust despite threats of therapeutic substitution, generic erosion
and potential US healthcare reform when viewed against weakening earnings momentum
across the EU market. Certainly at least over the next two years, threats to earnings growth
from therapeutic substitution, patent challenges (AZN aside) and regulatory setbacks given
limited new launch expectations seem modest in the face of ongoing productivity
improvements, cost cutting measures and share buybacks programs. Relative to an average
21% P/E premium to the EU market over the past 20 years and a 35% P/E premium
witnessed in the 1990-92 recession when sector prospects were noticeable brighter, we
argued that EU pharma should modestly re-rating into the 15-20% P/E premium range.

Since the rebound from a mid-November 2007 low 4% P/E premium to the EU market, the
EU pharma sector has oscillated between an 8-20% P/E premium to the EU market reflecting
a volatile outlook with respect to the consumer/economic slowdown, inflationary pressures
and the health of the financial sector. The 2008 P/E multiple of the EU pharma large-caps has
contracted by 12% points against circa 9% for the European market reflecting conservative
2008 outlook statements, earnings estimates for the EU pharma large-caps have been
lowered by c.4%. Following numerous patent settlements over the past 12 months,
exposure to patent challenge risk in 2008 appears low aside from a much speculated but still
unlikely launch at risk on Seroquel/Nexium. Together with a low dependency on new product
approvals and the initiation of new share buyback programs, we believe that earnings
estimates may well have bottomed out in sharp contrast to the wider market.