Markets

Pfizer's Generic Sales Slump by 14%; That's "Underlying Growth" to You

By Jim Edwards

Updated on: February 3, 2011 / 6:01 PM EST / MoneyWatch

New Pfizer (PFE) CEO Ian Read used his Q4 2010 earnings call to reaffirm his commitment to the company's generic drugs unit, even though sales of the company's "established products" are in decline. Former chief Jeff Kindler made growth of the unit and Pfizer's Greenstone generics division one of his main strategic goals following the merger with Wyeth.

Sales of Pfizer's old, off-patent drugs declined 14 percent to $2.4 billion last quarter. Those products include the antidepressant Effexor, the high blood pressure med Norvasc and the heartburn pill Protonix. That slump, despite two years' of special attention from management, prompted questions from two Wall Street analysts this week. Read said:

I think on the Established Products, it's a core business for unit for us. It's doing what we ask it to do. I think we're going to evaluate, as I said, all of our business units during 2011 from a point of view of their strategic positioning and return.

In response to another question, EP chief David Simmons said:

Without a strong generics capability, we don't believe we can meet or exceed underlying market growth.

How Pfizer can turn a 14 percent tumble into "underlying market growth" isn't clear. More and more branded drugs such as Lipitor and Viagra are coming off patent soon and will face cheap generic competition, so Simmons is right when he says the generics market as a whole is rising. The fact that Pfizer isn't benefiting from that is, therefore, a concern.

It's the same story at Eli Lilly (LLY), which announced a "branded generics" strategy of its own last year. Lilly's generic sales went down 4 percent in Q4 2010 to $467 million.

So the overarching question here is, do generics add or detract value, in general? In 2010 I looked at Teva (TEVA), the largest pure-play generics company. Although it had increased its revenues and net income over time, its margins had been squeezed despite getting efficiencies in its manufacturing costs. Those margins were hurt by Teva's ever-growing marketing budget. I crunched the numbers again this week and got this:

(The timeline in this chart reads from right to left, the opposite of what you'd expect.)

Teva, as an expert in marketing generics, ought to get the best margins in this business. Indeed, its gross profit margin (sales minus manufacturing costs) continues to rise. But the operating profit margin (sales minus all its various operating costs), while improved, is still mainly down from four years ago. The biggest non-manufacturing operating cost Teva has is sales and marketing.

What we can learn from this is that the generics business behaves exactly the way you'd think it does: You can only make a profit by squeezing your own margins as much as possible and by out-marketing competitors with identical products. That might increase your revenue, but proportionately it actually destroys value rather than creating it: As you grow, you take home a smaller percentage of what you make.

One presumes that Pfizer's Read and Lilly CEO John Lechleiter are aware of this.

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Image of generic beer by Flickr user miserloujones, CC.