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Roche Holding (OTCQX:RHHBY) has had an impressive ride in the last couple of months as its stock price has soared close to 40% since we initiated coverage on the drug maker. Continued growth across business segments and some positive developments regarding its pipeline largely drove this huge appreciation. In its Q4 earnings, the drug maker reported a 4% increase (at constant exchange rate or CER) in total revenues in Swiss francs, bucking the trend of declining revenues shown by other big pharma companies. In the wake of earnings and recent developments, we have increased our price estimate for Roche Holding to $46 from $58, which is about 5% ahead of current market price.

Below, we discuss the changes made and the outlook in detail.

Strong Pipeline Supports Upside

Roche has invested heavily in its R&D program, and owns one of the strongest pipeline among pharmaceutical companies (Read Roche Defends $47 Value With Strong R&D Pipeline). Most of its promising pipeline drugs are in the Oncology division, where the drug maker has a formidable presence. While Roche has already launched one of potential blockbuster, Perjeta, in several markets, it has also filed approval applications for T-DM1.

Both of these drugs target mainly HER2-positive breast cancer. With the strong efficacy exhibited in clinical trials, we believe the probability of T-DM1 getting FDA approval has increased significantly. The FDA has already granted its application a priority review, which means the drug could be approved by mid-2013. Accordingly, we have incorporated expected revenues from the drug. We expect the drug to garner more than $1 billion in peak sales for its currently targeted indication.

A few weeks ago, another blockbuster potential drug Obinutuzumab (GA101) showed impressive efficacy in improving progression-free survival in chronic lymphocytic leukemia (a type of blood and bone cancer) patients. In the first stage of a phase III study called CLL11, the drug, in combination with chemotherapy, significantly reduced the risk of disease worsening or death compared to chemotherapy alone in previously untreated patients. Further, an additional study suggested that the experimental drug could show superior efficacy compared with Roche’s own MabThera/Rituxan as a first line treatment for the condition. While the drug still has a long way to go for the approval (expected approval in 2014), we think it has a fair chance of succeeding now, and thus, we have incorporated expected sales of the drug in our model.

We have also increased our sales expectations from its several established drugs. Mabthera/Rituxan is seeing a continued uptake in demand, especially from emerging markets. Herceptin sales have been helped by Roche’s strategy to combine drugs with companion diagnostics. The drug maker’s other largest selling cancer drug, Avastin, is seeing astounding growth in the Western Europe market for ovarian and lung cancer condition. According to management, Avastin gained significant market share for ovarian cancer in the region, and this trend is expected to continue.

We have, however, lowered our sales expectations from Hepatitis C vaccine Pegasys. While the drug exhibited double-digit growth in the last couple of quarters due to its use in triple-combination therapy, patients are going off the therapy, and this should result in declining sales going forward. In addition to Pegasys, we have also lowered our sales expectations from Bonviva and Neorecormon, as they continue to lose revenues at an accelerating rate amid generic competition.

In the Diagnostic division, we have lowered Roche’s expected market share largely due to weakness in its diabetes franchise. Adding to the pain, Roche has been facing pricing pressure in developed markets.

While we expect gross margins (for both pharma and diagnostics) to decline going forward due to a change in product mix and pricing pressure, the decline may not be as steep as we had earlier anticipated, and so we have slightly revised our gross margin expectation. Further, we have reduced our forecast for R&D expenditures and selling, informational & administrative (SI&A) expenses due to Roche’s aggressive efforts to cut costs to drive operating profit. All of these factors have led to an increase in our price estimate.

However, there are other factors that could have an impact on our price estimate. The company’s experimental cardiovascular drug, RG7652, is moving toward advanced trials after significantly reducing levels of bad LDL cholesterol. Roche’s pipeline for Alzheimers also looks promising. And any success here will lead to upside in our price estimate.

Check out our complete analysis of Roche Holding

Disclosure: No positions.

Source: Roche Holding: Revised $58 Price Estimate On Strong Pipeline