XPH - XPH: Non-Diversified U.S.-Based Large-Cap Pharma ETF Isn't Very Attractive

2023-07-16 10:24:01 ET

Summary

• XPH’s consistent low yield and poor price growth (mostly negative) over both short-run as well as over long-run should be disheartening for investors.
• Expiration of a large number of patents within 2030, and narrow revenue stream expected from orphan drugs will impact the pharmaceutical industry.
• Revlimid, Januvia/Janumet, Reyvow, Bedaquiline, Keytruda, Opdivo, Eliquis, Ibrance, Stelara, Trulicity - all drugs are going to become off-patent by 2030.
• As XPH’s portfolio is highly concentrated on large-cap pharmaceuticals only, patent expiry and orphan drug development will surely be detrimental for it.

~ by Snehasish Chaudhuri, MBA (Finance)

SPDR S&P Pharmaceuticals ETF ( XPH ) is an exchange traded fund that invests in stocks of U.S. based pharmaceutical companies. This fund pays quarterly dividends with an unusually low yield and thus is meant only for growth-seeking investors. Unfortunately, this fund failed to generate price growth both in the short-term, as well as in the long-term. US pharmaceutical companies are also facing a major challenge in the form of patent expiration during this decade. Revenue replacement efforts into orphan drug development may also lead to lower quality of revenues, as these rare diseases generally have a relatively smaller and limited addressable market.

XPH’s Portfolio Consists of All Major U.S. Based Large-Cap Pharma Stocks

SPDR S&P Pharmaceuticals ETF was launched by State Street Global Advisors, Inc., and is managed by SSGA Funds Management, Inc. The fund seeks to track the performance of the S&P Pharmaceuticals Select Industry Index, by using representative sampling techniques. It has an AUM of $219 million and has an expense ratio of 0.35 percent. 71 percent of XPH’s portfolio consisted of only 16 stocks, that included all 5 U.S. based pharmaceutical giants namely Johnson & Johnson ( JNJ ), Eli Lilly and Company ( LLY ), Merck & Co., Inc. ( MRK ), Bristol-Myers Squibb Company ( BMY ) and Pfizer Inc. ( PFE ).

Zoetis Inc. ( ZTS ), Viatris Inc. ( VTRS ), Organon & Co. ( OGN ), Elanco Animal Health Incorporated ( ELAN ), Jazz Pharmaceuticals plc ( JAZZ ), Catalent, Inc. ( CTLT ), Royalty Pharma plc ( RPRX ), Intra-Cellular Therapies, Inc. ( ITCI ), Reata Pharmaceuticals, Inc. ( RETA ), Axsome Therapeutics, Inc. ( AXSM ), and Perrigo Company plc ( PRGO ) completes the list. These firms, too, have high market capitalization. SPDR S&P Pharmaceuticals ETF that was formed during June, 2006, in some way is a barometer of performance for the U.S. pharma stocks.

Returns of Pharma Stocks as well as XPH are Discouraging for Its Investors

During 2023, only RETA, ITCI, LLY, and ZTS generated positive price growth. Over the past 5 years too, only six stocks - AXSM, MRK, RETA, ITCI, LLY, and ZTS registered a price growth in excess of 5 percent. Interestingly LLY is the only pharmaceutical giant that posted better performance. All these stocks may be much more stable than stocks of other healthcare segments, but their returns are of very low quality. Over the past three years, PXB’s price fell by almost 3 percent, and over the past 5 years, it fell by almost 10 percent.

Between 2016 and 2021, when the market conditions were substantially better and almost all funds generated strong returns, XPH delivered an annual average total return of only 0.55 percent. This fund also has a very low trailing-12-months yield of 1.38 percent and is trading almost at par with its net asset value. Overall, SPDR S&P Pharmaceuticals ETF is discouraging for both income-seeking investors as well as long-term growth-seeking investors.

US Pharmaceutical Companies Are Facing the Challenge of Patent Expiration Within 2030

US pharmaceutical companies will face a major challenge in the form of patent expiration, which may result in a loss of $200 billion in annual revenues. According to ZS Associates, till 2030, top 10 pharmaceutical manufacturers combined have more than 46 percent of their revenues at risk and 5 companies have more than 50 percent of their revenues at risk. MRK’s Keytruda and Januvia/Janumet, BMY’s Revlimid and Opdivo, PFE’s Eliquis and Ibrance, JNJ’s Stelara and Bedaquiline, LLY’s Trulicity and Reyvow are going to become off-patent within this decade. These are all blockbuster drugs for these US pharmaceutical giants. During 2020, estimated sales of these 10 drugs was at least $70 billion. As discussed, SPDR S&P Pharmaceuticals ETF has substantial exposure to all of these five US based pharmaceutical giants.

Orphan Drug Development Makes Revenue Less Predictable and More Risky

Expected patent expiration and rising research & development costs have made pharmaceutical companies focus on orphan drug development . This is a niche area where drug development is aimed at rare disease treatment. For obvious reasons, such drugs have less competition and, once successful, can generate steady revenue streams. Orphan drug development has higher entry barriers due to high cost and time required for development of such drugs. As a result, revenue replacement efforts of pharmaceutical companies into orphan drug development leads to a less predictable and riskier revenue stream. However, it reduces the quality of revenues, as these rare diseases generally have a relatively smaller and limited addressable market. Chances of successful commercialization are also much lower than the traditional drugs.

Investment Thesis

SPDR S&P Pharmaceuticals ETF focusses on U.S. based pharmaceutical firms. The fund lacks diversification, as the portfolio is highly concentrated on large-cap pharmaceuticals only. These stocks failed to perform over the past five years. Its consistent low yield should be disheartening for income-seeking investors. XPH is also trading almost at par with its net asset value. The fund does possess some potential to generate absolute returns, but that is only possible in case the market moves up. However, both over the short-run, as well as over the long-run, the fund’s return has been extremely disappointing.

Not only that, this fund fails to generate hope in the minds of growth-seeking investors primarily due to two factors - revenue loss due to expiration of large number of patents within 2030, and less predictable and narrow revenue stream expected from successful commercialization of orphan drugs, which the big pharmaceutical companies are focusing upon. It’ll be extremely difficult for the pharmaceutical industry to cope up with an expected annual revenue loss of $200 billion. XPH will have to suffer due to its high exposure to firms whose patents are set to expire in this decade. In my opinion, SPDR S&P Pharmaceuticals ETF fails to provide any attractiveness to its investors.

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