Are BioPharma companies the next big tariffs victim?
We assume that pharmaceutical tariffs will be enacted. While this could bring short-term margin pressure, we have not changed our valuations.
President Trump has announced that “major” pharmaceutical product tariffs are likely to be revealed soon, but at the same time, paused broader tariffs for most trade partners for 90 days to allow time for negotiations.
The biopharma industry has largely been exempt from tariffs (except for 20% tariffs on imports to the US from China, implemented in March). The industry continues to brace for a potential pharma-specific announcement, which could have implications for global manufacturing strategies.
Rumoured 25% tariff
The rumoured 25% tariff could be applied to products manufactured in Europe and imported into the US. While there might be some flexibility to move toward a more domestic manufacturing strategy, avoiding tariffs completely would require new facilities that take several years to build.
Both US and Europe-based firms have significant European manufacturing exposure due to tax advantages (US firms), home country manufacturing (Europe firms), and other reasons, including lower production costs and lower exposure to currency fluctuations.
We assume pharmaceutical tariffs are enacted but do not last after 2026 due to political pressure from midterm elections. In this scenario, we think biopharma is unlikely to wholesale rethink its manufacturing footprint, apart from incremental US capacity additions.
How could tariffs impact pharma earnings?
Using a non-GAAP industry average margin analysis of the short-run tariff impact, a 25% tariff would only amount to a 2-percentage-point operating margin headwind in the worst case, or a 6% headwind to operating profits, using an industry average 32% operating profit margin.
That being said, in a prolonged recession, less funding for biotech could put pressure on industry productivity. We continue to see a low probability of a broad US price reset to international levels, which would require the endorsement of a Republican-controlled Congress that does not support price controls.
With industry gross margins generally around 85% after excluding profit-sharing agreements and roughly 55% of industry sales stemming from US-branded drug sales, we think a reasonable maximum target for a tariff would be the 50% of manufacturing costs, or 7.5% of global sales, that are destined for the US market.
In reality, this number is likely even lower because of depreciation costs embedded in the cost of sales line, significant US manufacturing footprints for many firms, and the higher-margin nature of US-branded drug sales (making them a lower percentage of manufacturing costs than the revenue split would imply). But if we apply a 25% tariff to 7.5% of sales, this yields less than a 2-percentage point hit to gross margins and operating margins.
Other things to consider
This analysis also does not consider the ability of wide-moat biopharma firms to pass on their cost increases in the form of higher prices; we think many higher-priced differentiated products could support this strategy to help counter any tariff pressure.
Regardless of whether tariffs take hold for a significant time span, we think the roughly 15% tax rates enjoyed by many US biopharma firms could begin to inch up closer to the 21% US corporate tax rate over time, as tax advantages from international manufacturing could be removed.
We already have tax rates increasing over time in most of our models, and we don’t expect any significant fair value estimate changes as we further update our models.
No change to Uncertainty or Fair Value ratings
We are not changing our biopharma uncertainty ratings or fair value estimates, as we think the direct impact from tariffs on earnings is likely to be limited in scope. Moreover, the indirect impact from a potential recession should also be limited given the noncyclical nature of drug spending.
Big picture, we think investors are likely to weigh the safe-haven nature of healthcare against the threat of potential US policy changes like international reference pricing. The healthcare sector tends to see relatively minimal impact to growth rates and margins during a recession because of the inelastic nature of healthcare demand.
