Introduction to Part 2
Part 1 of this 2-part series on Roche (OTCQX:RHHBY), the world’s largest biotech company, delves into some of the details of its strategy to overcome the ongoing, rolling EU/US patent expirations of its Big 3 oncology products of MabThera/Rituxan, Herceptin and Avastin, and resultant sales declines as biosimilars enter the market. RHHBY implemented a forward-looking strategy for this inevitable process years ago, the results of which are showing up in a series of young, often blockbuster drugs.
The major part of the strategy was straightforward: to develop next-generation drugs within a class (Gazyva as one example) and totally new drugs in therapeutic areas new to RHHBY (Ocrevus, Hemlibra as examples).
The secondary part of its strategy included restraining the sales drop-off, such as by developing new formulations of Herceptin and Rituxan/MabThera and by tying sales of the fading brand to a patent-protected brand. An example of the latter approach is showing that adding the younger drug Perjeta to Herceptin in a form of breast cancer aided survival. The goal included helping Herceptin sales by arguing that it is not clear that a biosim to Herceptin would work as well with Perjeta as Herceptin itself.
This article first assesses this strategy in quantitative, dollar-based terms (rather than doing a science-first approach).
Then, a review of some of the relevant news that broke from June 2 on will allow a little focused commentary about a few of the numerous moving parts of this complicated company. June 2 is chosen because that was the date of my previous RHHBY article, ‘Big Dog’ Biotech Roche Makes Progress: Will The Stock Notice?. The ADRs were at $27.38 then, so the stock has noticed just a bit, but it remains unchanged from years ago.
A comment on the news of the day that the Trump administration is trying to cut Medicare spending costs is provided in the conclusion of the article.
This article uses the $7.5 B that RHHBY earned in H1 this year (IFRS, not GAAP) as the forward earnings rate. At Wednesday’s closing stock price for RHHBY of $30.45, RHHBY is at a $210 B market cap and my estimate of its forward P/E is 14X.
In order to avoid doing a 3-part series, this wrap-up is long and a bit detailed.
How RHHBY plans to grow through the patent cliff/slope: sustaining the brands
I’d like to translate a busy slide. Basically, RHHBY is trying to convince investors that the company will grow even as the Big 3, all with sales in the $6-7 B range per year, decline at some pace. Three strategies for sustaining the brands need discussion.
1. New formulations of the same drug
Two of the three, MabThera/Rituxan and Herceptin, have had subcutaneous versions approved, rather than the IV versions. The s.c. versions take up just a few minutes of clinic time, and there is a significant cost per hour just for a patient to take up a chair. So, if the biosim to, say, MabThera is not at too great a discount to the s.c. version of the brand, the all-in cost to a clinic can be less if it uses a full-price, branded biologic rather than the cheaper biosim product.
RHHBY reports a good deal of success using the s.c. gambit, but acknowledges that if biosims drop in price enough, this tactic will fail or force it to discount its prices further. So it’s a stopgap tactic. Down the road, finding ways to allow the branded product to be self-administered at home would be a major step forward, but I have no indication that something like this is in the works for any of the Big 3 drugs.
2. Maintaining share with the basic brand at the highest selling price viable
The biosim threat to brands is nothing like what generics do to traditional (small molecule) drugs, where sales of the brand product tend toward zero almost as soon as more than one generic enters. In the worst case scenario the brand biotech company could simply compete as a biosim product, either under its own aegis or via an authorized biosim. In either case, I would expect it to gain the #1 position among biosims. Plus, the number of competitors in the biosim market is smaller than in most generics, and so long as the drug remains useful, I am going to assume that the worst case for the brand is somewhere around 15% of peak sales (say, 25+% market share at a discounted price).
3. Tie-in with new combination therapies
Because technically, biosims are not specifically substitutable for the branded biologic, the brands are trying to hold onto market share by studying an old drug with a young one. In addition to growing sales of the young drug, the secondary goal is to have the old branded drug used, not a biosim. RHHBY did the APHINITY study of the old drug Herceptin with the younger one Perjeta. The combination saved lives in a form of breast cancer versus using Herceptin alone. RHHBY can argues that the entirety of what is in a Herceptin infusion goes beyond the antibody, and that a further uncertainty is introduced when asking if the antibody in Perjeta works precisely as well with a biosim antibody with the structure of Herceptin but other ingredients that differ from those found in a Herceptin infustion.
I’m not sure how well this argument is playing out in the real world.
Interim summary – guesstimating sales of the Big 3 in 5 years
Based on existing trends in the EU and US, I am going to guess that in Year 5 from now, their sales will drop from nearly $21 B annualized (and $20 B 12-month forward sales) to $4 B. Of course, that’s a placeholder number, and profits will likely drop faster than sales. Still, it’s something to remember, and it’s a global number, not just US/EU, so sales in China and elsewhere might make this projection somewhat conservative.
Importantly, there is no need to get into the details of the shape of the curve of the decline. Meaning, if forward sales are $20 B, the path by which they might decline to, perhaps, $4 B is important, but not of critical importance. Because this involves three drugs in two major venues – EU usually first, then the US – and numerous secondary territories where sales may grow – this is a process, more a “patent slope” than the more common term of patent cliff.
Next, a word on the concepts behind Slide 12.
Reorganizing RHHBY’s explanation of its strategy
Now, looking at Slide 12, RHHBY’s chart was put together in my opinion by scientists, not financial people. The first column lists the Big 3. The second column tries to organize therapeutically related drugs, the third column lists unrelated drugs, and the 4th column lists recent achievements and other matters. The slide mixes marketed products such as Gazyva and Ocrevus with pipeline drugs.
I would rather ignore pipeline drugs, and think that a number (but not all) of the younger marketed drugs may make up for the decline in sales of the Big 3.
Note I am making lots of forward-looking guesses here. Only time will tell how far off the mark I am, but you should not use the numbers herein for an investment decision. But you may wish to think about things and use my thought processes and any facts I adduce in making your own assessments.
Ocrevus for MabThera/Rituxan
Ocrevus is on a trajectory to become the world’s leading drug for multiple sclerosis. Just approved last year, Ocrevus is the only drug approved for the serious disease form called primary progressive MS, or PPMS. Ocrevus is also approved for relapsing MS, also called relapsing-remitting MS (RMS or RRMS). In the conference call, the CEO of Roche Pharmaceuticals, Daniel O’Day, reported that in a global MS market that exceeds $20 B:
… one out of every three patients that are new or that switch therapy in the MS base are going on Ocrevus. So we have around a 30% new and switching share…
I have been carrying Ocrevus as a $5 B peak product, and getting to high levels quickly; in Q2, it annualized around $2.2 B – and that’s with the ex-US sales just ramping up. Its advantages include twice-yearly dosing. The drug is given IV and requires pre-medication. Since stable patients may see a neurologist only twice a year, the convenience factor for both doctor and patient is very high with this situation.
There are some negatives or potential negatives here. Ocrevus is young, and certain risks related to its novel (B-cell) mode of action still exist, and could be material. Also, the underlying technology is similar to that used for MabThera/Rituxan and Gazyva; Biogen (BIIB) will receive around 12% of Ocrevus sales as royalties. This is, however, lower than the royalty rate on MabThera/Rituxan sales, as this old drug was invented by a predecessor company of BIIB. In contrast, the underlying patent is old now, and I believe that Ocrevus was invented internally within RHHBY or a predecessor company (i.e. Genentech).
With Ocrevus seemingly close to annualizing at $3 B, retaining a high share of patients who start therapy on it, with possible use in secondary progressive MS in addition to PPMS and RMS, with no competitor imminent, I look at the profit potential from this drug as probably fully replacing the future lost profits from MabThera/Rituxan.
Moving on, we can look at the angiogenesis inhibitor that has proved such an important drug.
Avastin – how to match it
I’m projecting a modest drop in forward Avastin sales to $6.8 B. This cancer agent has begun to lose sales organically due mostly to being displaced by from immuno-oncology (I-O) drugs in lung cancer.
I look at Avastin mostly as RHHBY does in that RHHBY correctly puts Tecentriq on the same line (next column) to it. This makes sense; each is active against many forms of cancer. However, Tecentriq is not expected to reach Avastin’s sales, due to Keytruda’s dominance in front-line lung cancer. I have seen consensus of $5 B peak sales for Tecentriq, and will go with $4.5-5 B for this drug.
Then I would add another drug with lots of growth potential, Gazyva, for reasons described later. It is annualizing around $750 MM, but the latest data (see below) may, I believe, make it a $2 B drug.
Thus I look at Avastin as probably compensated for by Tecentriq and Gazyva. Avastin has been paired in more than one disease with Tecentriq, and perhaps Avastin’s sales will therefore hold up better than expected against biosims.
That leaves the biggest seller, which is still growing:
Even Herceptin can be replaced
Herceptin annualized around $7.2 B in H1, and was still growing. I believe that its income can be replaced, unless sales surge a good deal more before declining (which would be OK). Here’s my reasoning:
First, Perjeta is placed by RHHBY in Column 2 in the same line as Herceptin, and is appropriate there. Perjeta sales have begun to rise sharply due to APHINITY, annualizing at $2.8 B, up 28% yoy. I expect this surge to continue and expect that peak sales may be in the $5 B. Then there is Hemlibra, which is approved for a rare, complicated form of hemophilia A, but is expected to also be approved for hemophilia A in general. I think this product is best-in-class both for its approved indication and its pending, much broader indication. I expect billions of dollars a year in sales, but “how high this moon?” It’s tough to say.
So I will guess that Perjeta plus Hemlibra will replace Herceptin. Note, though, that the time frame to match its sales may well not line up perfectly year by year; i.e. Herceptin could decline faster than Perjeta/Hemlibra sales rise.
Because I don’t know Herceptin’s peak sales yet and Perjeta and Hemlibra must prove themselves, I will proffer yet another marketed, young drug: Venclexta. This is expected to be a mega-blockbuster for cancer, but AbbVie (ABBV) is the main marketer, and I do not believe that RHHBY and ABBV have spelled out the profit split. Because I sense ABBV will get the lion’s share of the profits, I’m going to be cautious on Venclexta. But I think it will be meaningful to RHHBY and that it has a very long protected sales period.
Interim summary – replacing and growing these franchises
All in all, I think that the entirety of sales from the Big 3 oncology drugs can be offset by currently-marketed young drugs. In addition, assuming that the $20-21 B in current/forward sales from these aged drugs shrinks to $4 B in 5 years, then under the above analyses, sales of these 3 old drugs plus the several young ones discussed above would rise from about $20 B to about $24 B over the proposed 4-5 year time frame. That’s a 4% growth rate per year, and as the old drugs lose profit margin, the young ones will gain margin. So if all the rest of the business were to grow at that same (projected) 4%, and if RHHBY is now trading at a 14X multiple, then I further assess that at the end of about a 5 year time frame, RHHBY will be viewed as worthy of more like an 18X multiple, which I view as its “normal” multiple.
Putting it all together, and estimating a forward dividend yield around 4%, I project about a 14% CAGR for total returns from RHHBY over the next 5 years or so. The three pillars of this total return include profit growth, P/E expansion, and growing dividends.
However, I think that returns could well be better than that for new money investors right now, because of…
The pipeline and recent drug approvals reflect superior R&D
Some parts of the pipeline were stuck into the company’s thematic presentation, but in the above analysis, I only used approved drugs; though in several cases, I assumed growth from one or more additional indications. RHHBY spends a high 22% of pharma revenues on pharma R&D, and as it points out over and over again, such as on Slide 10, it has an industry-leading record since 2013 of Breakthrough products (an FDA designation for highly innovative products). The very high R&D spend improves quality of earnings and makes the 14X P/E cheaper than it appears. In the real world, this spending appears to have been generating a high ROIC, and I expect that if the P/E of a broad large cap index such as the S&P 500 (SPY) holds up, then RHHBY actually should receive a 20X or higher P/E if and when it successfully works through its ongoing patent issues. But I also expect reversion to the mean in P/E’s in the market as a whole, so I am sticking with 18X as a normalized, above-market P/E for RHHBY.
The strength of RHHBY’s pipeline goes far beyond the specific products listed on Slide 12, however. It reflects what I think is best-in-class R&D capabilities. Just look at the new drugs: Ocrevus, a highly innovative approach to MS; Hemlibra, a highly differentiated approach to hemophilia A; the innovative Perjeta and the high risk but successful APHINITY study; the first-in-class RoActemra/Actemra; Venclexta; the many innovative Phase 3 and Phase 2 products in development; etc.
I’m bullish on RHHBY’s R&D.
The company maintains several arrays and presentations of its pipeline; here is a link to one that shows the pipeline and also provides links to other ways to look at it.
All the above represents just my considered opinion; it will take years, not weeks or months, for the truth to play out.
Moving along to today’s investment decisions, what may make a difference in how the stock trades in the near-term could come from the slew of positive news from RHHBY. The right-hand column of Slide 12 lists much of that news, and in the next section, I will review some of what the company has announced beginning with June 2, the date my last RHHBY article was published. And remember, that article was written to summarize recent good news that came before June 2. So I see RHHBY as being on quite a roll.
More good news than many Big Pharma companies announce in a year, in only two months
I’m going to run through several of the company’s press releases that were issued after I submitted my last RHHBY article, with one link to the company’s press release page and if appropriate quotes from the article, which will be indented; followed by my brief commentary (non-indented). First:
2 June 2018
Phase III IMpower131 study showed Tecentriq (atezolizumab) plus chemotherapy (carboplatin and Abraxane) reduced the risk of disease worsening or death for people with advanced squamous non-small cell lung cancer
This is good news showing that Tecentriq is active in front-line NSCLC. The data were from an interim analysis showing significant PFS (progression-free survival, per the title; more time is needed to see if OS (overall survival) is favorably affected.
At this point, 9 weeks ago, there was little doubt that Keytruda was the big I-O winner in front-line NSCLC, but showing that Tecentriq is a credible agent in the disease may have helped the stock bottom and move back above $30. Next:
Basel, 05 June 2018
FDA grants Priority Review to Roche’s Hemlibra for people with haemophilia A without factor VIII inhibitors
Roche (SIX: RO, ROG; OTCQX: RHHBY) today announced that the US Food and Drug Administration (FDA) has accepted the company’s supplemental Biologics License Application (sBLA) and granted Priority Review for Hemlibra® (emicizumab-kxwh) for adults and children with haemophilia A without factor VIII inhibitors. The sBLA is based on data from the phase III HAVEN 3 study. The FDA is expected to make a decision on approval by 4 October 2018.
Hemophilia A without inhibitors is the most common form of the disease. New high-tech treatments have been emerging that greatly improve treatment options.
That the FDA has granted a Priority Review to this, proposed second indication for Hemlibra (sBLA), supports the bulls. Next:
Basel, 11 June 2018
Roche announces FDA approval for Venclexta plus Rituxan for people with previously treated chronic lymphocytic leukaemia
- Approval based on phase III MURANO study showing Venclexta plus Rituxan reduced risk of disease progression or death by 81% compared to bendamustine plus Rituxan
Venclexta has been co-developed with ABBV. Bendamustine is a chemo agent. That Rituxan/MabThera works much better with Venclexta than with chemo – an amazing 81% reduction in diseases progression or death – is a powerful matter.
Venclexta may become an important front-line drug for CLL.
Basel, 14 June 2018
Roche announces new OCREVUS (ocrelizumab) data on long-term disability benefits in primary progressive multiple sclerosis and initiation of two global studies in progressive multiple sclerosis
- OCREVUS may delay the need for a wheelchair by seven years for people with primary progressive multiple sclerosis (PPMS)
- Longer-term efficacy and safety data are consistent with OCREVUS’ favourable benefit-risk profile for both PPMS and relapsing MS (RMS)
- Two new Phase IIIb studies for OCREVUS in progressive MS will use novel endpoints to evaluate upper-limb function and disability progression
One of the two Phase IIIb (aka Phase 4 in common US parlance) is called CONSONANCE and will study primary progressive MS and secondary progressive MS. This is a lengthy study and may or may not have interim analyses; 300 patients with SPMS will be studied. Whether it is registration for SPMS has not been defined by RHHBY. Next:
Basel, 15 June 2018
New long-term data confirm Roche’s Gazyva/Gazyvaro extends the lives of people with chronic lymphocytic leukaemia compared to MabThera/Rituxan
- After a follow-up time of nearly five years the CLL11 study shows a 51% reduction in the risk of disease progression or death with Gazyva/Gazyvaro compared to MabThera/Rituxan
- The final analysis reports a clinically meaningful overall survival benefit is seen for Gazyva/Gazyvaro compared to MabThera/Rituxan when combined with chlorambucil
- These data highlight the superiority of Gazyva/Gazyvaro-based treatment over MabThera/Rituxan-based treatment for patients with previously untreated CLL with comorbidities
This long term study could be important, perhaps decisive, in turning Gazyva from a moderate disappointment to a big hit. Currently, Gazyva has shown improved progression-free survival versus MabThera/Rituxan, but the 24% reduction in the risk of death is more impressive than improved PFS alone.
Now, I could go on, but you get the point. After June 15, the same web page shows:
- RRHBY going deeper into genomics/personalized medicine by acquiring Foundation Medicine
- Tecentriq providing a survival advantage in front-line small-cell lung cancer
- Tecentriq providing PFS advantage in a form of breast cancer, with a subset of patients showing encouraging survival data
- progress in the replacement for Tamiflu
- Breakthrough Therapy designation by the FDA for Tecentriq + Avastin in liver cancer (based on Phase 1 data)
- Tecentriq plus chemo beat chemo alone in front-line NSCLC; superior PFS was shown, and OS data was encouraging (interim data only; study will continue as planned)
- new data on its two Phase 3 antibodies for Alzheimer’s disease
- Priority Medicines (“PRIME”) designation by the European Medicines Agency for the Huntington’s disease compound in-licensed from Ionis (IONS).
That’s an awful lot of news for a 9-week stretch. And it comes after a run of good news as discussed in my June 2 RHHBY article.
I do not remember this much positive news flow ever coming from any Big Pharma company in a short time frame.
So here’s my wrap-up.
Conclusion: RHHBY is undervalued
Within the universe of large to very large, financially strong, generally conservative stocks from which to choose, RHHBY appears to me to be priced attractively. If one were to normalize its operations to those of Pfizer (PFE) or Merck (MRK), the two largest pharmaceutical enterprises in the US, one would slash RHHBY’s R&D budget by about $3 B. Given a 20% tax rate, that would increase RHHBY’s profits by $2.4 B, and my projected $15 B of profits for the next 12 months would increase to about $17 1/2 B. That in turn would lower my forward P/E from 14X to 12X. With that level, even if earnings collapsed 40% as the Big 3 fell rapidly to biosim competition and little replaced their earnings, the adjusted P/E would only be 20X and the P/E using current R&D spending would only be 23X.
Yet when Lilly (LLY) and others suffered trough earnings due to patent expiries, their P/E’s went into the 30s.
Supporting my view that RHHBY is undervalued relative to its peers is that almost all its marketed products are/were first-/best-in-class, and RHHBY strives to continue that tradition in its pipeline efforts. It also does not bother with making its own biosims to products of other companies, which it easily could do. In contrast, PFE and Amgen (AMGN) engage in this less profitable, commodity-like effort, just as the generic companies Teva (TEVA) and Mylan (MYL) do. (PFE also has a generic division, Greenstone.) The hierarchy of chemicals, and (usually) relative P/E, rises from bulk chemicals to specialty chemicals to generics to brand pharma to first-/best-in-class pharma/biotech compounds. RHHBY therefore sits at the tippy-top of a pyramid with very few peers. With ongoing cutting-edge R&D which is performed with profit and loss in mind, RHHBY may, perhaps sooner rather than later, be recognized as having been on the bargain counter right now.
Finally, a word about the Trump administration’s efforts to restrain Federal spending on pharmaceuticals is in order. The latest news from the administration roiled some pharma/biotech stocks Wednesday. I look at this as an inevitable, intermittent, rearguard process. No one can know, but I suspect it is “in” the stocks. The topic has been au courant for almost three full years. Often the expectation is worse for the industry than the reality. When people get wealthier, after satisfying the very basic needs of life, they want and vote for more health care, not less. I predict it will not be different this time; the key is that while biotech is not cyclical, it does depend on a general level of prosperity, so in a sense, it is a play on economic growth. Thus if the administration achieves its goal of faster growth, it will not need to push too hard on spending. In any case, Congress knows that voters want spending on health care, so as I’ve been saying ever since Big Pharma/Big Biotech was made a villain during the 2016 campaign, I think all that really matters long term is whether there is over-investment or not in the pipelines. When there is over-investment, as happened in tech in the late ’90s, the stocks get hit. This has happened in biotech, and I think that RHHBY is coming through this period brilliantly. So my investment dollars take the position that all will be well long term in the high-tech pharma/biotech field for the consistent innovators.
A word on risk: all investing has risks; please review the company’s disclosures regarding them. RHHBY strikes me as having less risk than the average stock, but it remains a stock that can impose losses on investors.
In summary, I admire Roche’s strategy and tactical implementation of the strategy to grow through its patent and other challenges. I hold a meaningful position in RHHBY with a very patient, multi-year time frame. My goals are for low-to-mid double digit annual returns over the next 5 years, but I’d be fully satisfied with a 7-9% set of returns given what I view as a low-risk equity.
Thanks for reading and sharing any comments you wish to contribute.
Disclosure: I am/we are long RHHBY,ABBV.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Not investment advice. I am not an investment adviser.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.