Unfortunately, Q3 2016 reporting season disappointed the sell-side expectations, with results missing by 3% on the top line, 6% on Core EBIT and 4% on Core EPS, mainly driven by heritage Baxalta products (7% miss) while heritage Shire beat by 2%.
Total product sales increased 110% versus Q3 2015 to $3,315 million (Q3 2015: $1,577 million), primarily due to the inclusion of $1,546 million of legacy Baxalta sales. Excluding Baxalta, product sales increased 12% (13% on a Non-GAAP CER basis) with all legacy Shire franchises exhibiting growth in Q3 2016, with Neuroscience up 15%, Genetic Diseases up 5% and Internal Medicine up 15% compared with Q3 2015. Lastly, XIIDRA's launch in Dry Eye has been very strong, with the franchise contributed sales of $14 million.
During the conference call, Shire's management reassured investors explaining that the majority of Baxalta products' miss was related to phasing of some orders outside the United States, but that underlying trends for Heritage Baxalta were totally in line with market trends.
In addition to that, the most important growth drivers performed strongly:
- VYVANSE sales increased 20% driven by strong volume growth in ADHD and BED in the U.S., limited pricing benefit in the U.S. and substantial growth in International markets.
- LIALDA sales increased 18% with market share approaching 40% at the end of Q3 2016 in the IBS-D market.
- FIRAZYR sales increased 19% in Q3 2016 compared with Q3 2015 thanks to an increase in the number of patients on therapy in both U.S. and international markets. This has compensated the supply disruption that negatively impacted Cinryze.
- XIIDRA generated $14 million of product sales in Q3 2016, mainly due to initial launch stocking, but the most important point is that NBRx market share was already approaching 44% after few weeks from the launch.
Thus, the overall performance is encouraging, pointing towards a rebound of legacy Baxalta in Q4 2016 and a strong performance in 2017.
"The performance of the legacy Baxalta business was broadly in-line with our expectations following the strong double-digit pro forma growth in the first half of the year and is something I indicated we expected on the call last quarter. Starting with the Hematology franchise, revenues were approximately $884 million for the quarter, a decrease of 6% from the comparable period in the prior year, primarily due to the timing of large international orders.
Large orders for our Hemophilia products were approximately $25 million higher in Q3 2015 and approximately $25 million higher for our Inhibitor Therapies as well. Taken together, this $50 million headwind held back Q3 2016 Hematology product sales growth by approximately five percentage points"
Source: Jeffrey Poulton, Shire's CFO, Q3/2016 results conference call
Non-GAAP operating income increased 73% to $1,254 million (Q3 2015: $725 million), primarily due to the inclusion of a full quarter of Baxalta operating income and higher revenue from legacy Shire products. Non-GAAP EBITDA margin (excluding royalties and other revenue, and cost of sales related to contract manufacturing revenues) was 38% (Q3 2015: 43%). The decrease was primarily due to the impact of a full quarter of lower margin product franchises acquired with Baxalta and XIIDRA launch costs.
The most important comment from the call about the operating leverage is related to the synergies from Baxalta's integration. Shire affirmed to be ahead of schedule in generating these synergies, compared to the target of $700 mln of savings by the third year post integration. Thus, further synergies will be generated in 2017, helping to generate substantial operating leverage from the currently depressed profitability level.
Lastly, FY'16 guidance has been reiterated for a Diluted Earnings per ADS of $12.70-13.10, but management commented during the call that they expect EPS at the upper end of the range.
In conclusion, Q3 2016 results have not been taken positively by the market, but the miss can be explained by one-off factors while the performance of key growth drivers (Vyvanse, Immunology, Xiidra, Lialda, Firazyr) have been stronger than ever, thus reassuring about the ability of the company to deliver on 2017 estimates of double-digit sales growth.
The key risk on the bullish thesis on Shire is related to competition in haemophilia from Roche's ACE 910. It looks like a viable competitor to Shire's Hematology franchise in the longer term but I believe the scale of this threat is well understood and discounted in Shire's valuation, with the stock trading at 11x 2017 P/E despite higher EPS growth expected for the next 5 years.
This valuation doesn't make sense given the high visibility on the key growth drivers for the foreseeable future, so I would strongly chase the company at the current valuation.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.
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