You're not going to often hear me say that earnings don't matter, but I don't believe that Roche's (OTCQX:RHHBY) reported financials are going to be the driving factor behind the share price performance in 2016 and 2017. I am expecting that investors will, instead, put more emphasis on the company's clinical trial performance, as data read-outs over the next two years will go a long way toward shaping the future of Perjeta, Gazyva, and atezolizumab.
My basic view of Roche remains that the company is well-placed to play a major role in the evolving field of immuno-oncology and that recent clinical successes in hemophilia, asthma, and multiple sclerosis give it a little more of a balanced mix. I'm looking for Roche to generate around 5% long-term revenue growth, largely on the back of oncology, with additional cash flow leverage pushing the FCF growth rate into the high single-digits. Discounted back, that supports a fair value just shy of $36 today.
The Long Wait For 2017
Roche has been late to the PD-1 party, as Merck (NYSE:MRK) got its first approval of pembrolizumab (aka Keytruda) in the fall of 2014 and Bristol-Myers (NYSE:BMY) got its first approval of nivolumab (aka Opdivo) shortly thereafter. While these first approvals were in melanoma, subsequent approvals came in 2015 for non-small cell lung cancer (NSCLC).
For its part, Roche's PD-L1 antibody atezolizumab has no approvals at all yet, but that should change in 2016. Roche is well on track with atezolizumab in bladder cancer, an indication that in some respects will be atezo's version of melanoma (a relatively small market opportunity, but with poor outcomes in advanced cases). Roche should also be able to secure second-line approval for atezo in NSCLC before the year is up.
The bigger question is what will happen in first-line NSCLC therapy, an indication that could perhaps be worth as much as $20 billion or more. Merck's Keynote 024 and Bristol-Myers' Checkmate 026 studies should both finish in 2016, with the former expected to reach primary completion at mid-year. These studies are both exploring front-line monotherapy, with pembrolizumab and nivolumab compared to platin-based chemotherapy, and are expected to support filings and approval for use.
The year after (2017) is when things start getting more interesting for Roche. While Merck and Bristol-Myers will likely both be ahead of Roche with pivotal first-line trials, Roche has a very robust late-stage trial program exploring atezo as a monotherapy and in combination with chemo and chemo with Avastin.
All told, Roche has six Phase III studies on the books for atezo in first-line NSCLC, testing atezo as a monotherapy, in combination with chemo, and in combination with chemo and Avastin. While three of these aren't expected to finish until 2019 or later, management believes they will have data from four of them (covering mono, mono+chemo, and mono+chemo+Avastin) in 2017.
Keep in mind, too, that there is a difference between finishing the study and generating enough data to indicate (and report) a meaningful response rate and extension of survival. So I would expect to see numerous clinical updates in the space in 2016 and 2017. That includes data from three Merck studies (two examining pembro as a monotherapy and one in combination with chemo), two Bristol-Myers studies (nivo as a standalone, in combo with ipilumumab (BMY's CTLA4 antibody), and in combo with chemo), and two AstraZeneca (NYSE:AZN) studies (durvalumab (anti-PD-L1) as a monotherapy and/or in combination with tremelimumab (anti-CTLA4)).
Here's the real takeaway - while Bristol-Myers and Merck have established the first-mover advantage in second-line/third-line NSCLC, and will probably be first to market with first-line monotherapy labels, the data that come out over the next two years or so will go a long way toward determining who gets the biggest pieces of that potentially $20 billion first-line market (which, by the way, will largely erode the second/third-line markets for PD-1/PD-L1 therapy).
It may well be the case that the combination of PD-1/PD-L1 and CTLA-4 proves quite powerful in terms of response rates and survival rates; the combination has been shown to be highly effective in melanoma, albeit at the cost of high rates of adverse events. If this plays out, Bristol-Myers and AstraZeneca will have a big edge against Merck and Roche for several years or more, as it will take time to develop alternative combos through pivotal studies.
If it turns out that combining PD-1/PD-L1 with chemo and/or Avastin is the way to go, Roche will likely have the earliest, richest dataset and will grab the leadership position. If it turns out that monotherapy is the way to go (an outcome that seems very unlikely to me), it'll be more of a toss-up, as Bristol-Myers and Merck will have first-mover advantage, but all of the companies will data-mine the heck out of their studies to show relative advantages for their drug.
And that's really just the beginning. There are a host of other immuno-oncology agents that can be conceptually be paired/combined with PD-1/PD-L1 drugs. Celldex's (NASDAQ:CLDX) varlilumab is in numerous combo studies (including with Bristol-Myers and Roche) and Roche will be presenting Phase I data on combos of atezo and OX40, IL2, and IDO throughout 2016. While Roche has what I believe to be the strongest pipeline of IO combo candidates (with nine in-house compounds in studies), AstraZeneca has done a very good job of filling out its roster. Merck and Bristol-Myers don't appear as robust by comparison, but at least, Bristol-Myers has been more active in partnering.
The immuno-oncology market is what you might charitably call an "evolving situation". Bristol-Myers and Merck are clearly the leaders in immuno-oncology today, and Bristol-Myers is well-placed if it should happen that PD-1/PD-L1 is a powerful (and safe enough) combo outside of melanoma. AstraZeneca has a lot riding on the success of the PD-L1/CTLA4 combo concept, while Roche is more heavily dependent on PD-L1 + chemo for the first generation. Looking further out into the 2020's, Roche and AstraZeneca would seem to have the better pipelines for IO+IO combos, but there is ample opportunity for Bristol-Myers, Merck, Pfizer (NYSE:PFE) and others to shrink that gap.
For Roche's part, the next few years are going to be chock-full of trial results that could significantly move market sentiment.
This year should see data from the APHINITY and GOYA studies, though the timelines are still uncertain at this point. APHINITY is studying the use of Perjeta in adjuvant breast cancer, while GOYA is studying the use of Gazyva in DLBCL (a type of lymphoma). APHINITY could add around three billion dollars in potential peak Perjeta sales, while GOYA's impact on Gazyva would likely be about half as much in a successful outcome. Given the looming risk of biosimilar competition to Herceptin and Rituxan (close to 30% of sales), success is important to near-term financial performance.
While the timing on APHINITY and GOYA isn't known, management said it expects to report Phase III LAVOLTA I & II trial results in May. These studies of lebrikizumab in asthma are higher-risk, but could lead to a late 2016 filing and $1 billion to $2 billion or more in sales.
Investors will be paying close attention to longer-term Phase I data on atezo+chemo in NSCLC at June's ASCO meeting, as this update could provide more information on the durability of response. While atezo has looked more effective (at least in some respects) than the approved PD-1 drugs, Bristol-Myers and others have argued that the response isn't/won't be as durable. Other read-outs in 2016 will provide information on atezo+chemo in colorectal cancer (Phase I; thus far a tricky target for PD-1/PD-L1), atezo+chemo in triple-neg breast cancer (Phase III; December), atezo+Avastin in renal cancer (Phase II), and the aforementioned atezo+IO combos (Phase I).
The Bottom Line
Roche isn't dramatically undervalued on a weighted-probability basis, with a fair value of about $36, but positive clinical trial results could push that target higher throughout 2016 and 2017 (and vice versa for disappointing outcomes). The IO field will be fiercely contested and thoroughly confusing for the foreseeable future, but Roche's deep pipeline and strong R&D platform in oncology give the company what I believe to be an above-average chance to emerge as a long-term winner.
Disclosure: I am/we are long RHHBY.
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.
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