AstraZeneca (OTCPK: AZNCF), will report its full-year results for 2016 on 2nd February 2017.
Shares of the company haven't done quite well over the past 6 months and they are currently trading not far from 52-week low, despite AstraZeneca is entering a critical phase with 4 key drugs which will report Phase III data in the next 12 months:
- Durvalumab/Tremelimumab in 1st line NSCLC from the Phase III MYSTIC trial.
- Lynparza, in various tumors, as breast cancer and ovarian cancer.
- Roxadustat to treat Anemia from the Phase III OLYMPUS trial.
- Acalabrutinib in CLL to assess if the profile of the drug is actually stronger than Abbvie's (NYSE:ABBV) Imbruvica.
In this article, I will preview the earnings report and some key themes for 2017 in addition to sell-side expectations.
Q4/2016 results & FY 2017 guidance
Investors seem anxious about AstraZeneca's FY 2016 results:
- Street expects $5.6B for Q4/2016 revenues, 11% decrease over prior-year period.
- Street expects $1.14 for core EPS, around 26% growth over 2016 EPS of $0.95, but driven by the Other Operating Income line, expected to be 100% higher than in Q4/2015.
- Investors expect that AstraZeneca will meet its 2016 guidance (i.e. low to mid single digit EPS decline at constant exchange rates).
For 2017, street expectations are that AstraZeneca will provide a guidance of low-mid single digit Revenue decline and low-mid teens Core EPS decline at constant exchange rates. What should be implied in this potential guidance?
Assuming 3% revenue decline at constant exchange rate and 2% forex headwind, I estimate 2017 revenue to be around $21.5B, approximately in line with street expectations.
Then, assuming a limited operating leverage, a 3% forex headwind and a tax rate back to the normalized level of 15%, I estimate a 2017 EPS figure of about $3.60, approximately in line with street expectations.
If consensus numbers seems in line with investor expectations, why there is nervousness around the FY 2016 results?
I believe that investor perceptions of AstraZeneca's 2017 guidance will be influenced by the outlook that the company will provide for Externalization revenue (EXT) and Other Operating Income (OOI). Consensus looks for more than $3B of EXT/OOI in 2016, up from $2,5B in 2015 and I think the company will require at least a similar amount of OOI in 2017 to match consensus numbers.
"So, just on the externalization revenue, I think I can say that this is part of our business model, and therefore we're expecting to continue the externalization revenue in 2017, 2018, and so on. So, yes, this is going to continue. To the question is what is the impact on lost sales on the forward years, it's more difficult to answer your question because obviously it depends on the ratio between externalized revenue and other income, and also it depends on the deal structure, whether we are letting the order value grow or not. So it's a very difficult question to answer. We will try to - next year for the guidance, try to provide some help in projecting these two lines of the P&L. But for the time being, what I can say, this is going to continue at a reasonable level for the years to come."
Source: AstraZeneca's Q3/2016 Conference Call Transcript
A key risk for the stock is that it's unreasonable to believe that a similar benefit could be expected in perpetuity. While Externalization revenue can be sustainable, because they are driven by recurring milestones on assets distributed in partnership, the Other Operating Income line comes from positive one - off related to asset disposal and I believe it's not a strategy that AstraZeneca could pursue forever.
If we assume that AstraZeneca will lose half of their OOI in 2019, the company could lose around $0.50 of EPS. Thus, consensus expectations for 2019 EPS could be downgraded by up to 15% in the next couple of years, if AstraZeneca will admit that the OOI is not sustainable, and the market has overlooked this risk.
Key catalyst in 2017
AstraZeneca has a broad presence in the immunotherapy (I/O) space and its most important clinical study which will be published in 2017 is the Phase III MYSTIC trial for Durvalumab / Tremelimumab (PD1/CTL4) in 1L NSCLC. I think this is the most important driver for the performance of the stock in 2017.
Unfortunately, the recent news flow has increased investor skepticism around this combo and, more in general, around the potential benefit of a PD1/CTL4 combo approach in lung cancer:
- On January 2017, BMY (NYSE:BMY) announced it is no longer pursuing an accelerated filing strategy for its Opdivo/Yervoy combination in 1st line lung cancer.
"Bristol-Myers Squibb Company announced today that it has decided not to pursue an accelerated regulatory pathway for the combination of Opdivo plus Yervoy in first-line lung cancer in the U.S. based on a review of data available at this time. In order to protect the integrity of ongoing registrational studies, the company will not be providing additional details."
In addition to that, BMY's FY 16 results have not helped to dissipate the doubts:
"The second area of focus for us is our first-line lung cancer program. And I do understand that it would be easier to be able to communicate more with respect to that program. But the reality is we do have four large ongoing Phase III programs, thus following the negative results last year of the study CheckMate-026, we have both an option to explore the I-O/I-O combo, which we remain committed to, and alternative strategies, which include I-O/chemotherapy as well as the potential to actually use a short-term cycle of chemotherapy in addition to our I-O/I-O regimen. So that is one of our priorities. And as I said in my remarks, we do believe we have an opportunity to have a meaningful role to play in the future in lung cancer."
Source: BMY's Q4/2016 Conference Call Transcript
Why BMY's management has said to be committed, but not confident in their PD1/CTL4 approach? Are they only conservative, after some setbacks in the space? Or does BMY believe that there is only a marginal benefit from adding a CTL4 to a PD1 and that a chemo/combo approach could be better?
It's impossible to express a clear view, but it's clear that the BMY's setback does not bode well for AstraZeneca, who is pursuing a similar approach in the I/O space.
- On January 2017, AstraZeneca has announced to have updated the trial design for their MYSTIC study, 6 months before the readout. The company has expressed clearly that they have made these changed to maximize the chances of success of the clinical trial and that they are really confident in a positive readout, but I think this update has not helped in restoring investor confidence in the AZN's strategy for the I/O space.
"The MYSTIC trial was initially designed to assess the benefit of Durvalumab monotherapy and Durvalumab and Tremelimumab (durva + treme) combination therapy versus standard-of-care (SoC) chemotherapy, focused on progression-free survival (PFS).
The MYSTIC trial will now assess PFS and overall survival (OS) endpoints in patients with PDL1-expressing tumours for both durvalumab monotherapy and the combination of durva + treme, as well as in 'all comers' for the combination of durva + treme, versus SoC chemotherapy.
While the focus remains on exploring the benefit of durva + treme as combination therapy, the Company has updated the endpoints of the MYSTIC trial to include OS and PFS in durvalumab monotherapy. This is based on recent internal and external data, including durvalumab's strong efficacy in monotherapy presented at recent medical meetings, as well as significant opportunities in the competitive landscape"
- There will be a lot of competition in this space, beyond BMY. For example, Merck & Co. (NYSE:MRK) and Roche (OTCQX:RHHBY) are pursuing a different approach for their combo in 1st line NSCLC, looking to a combination of PDL-1 and chemotherapy, instead of combining two I/O agents, PD1 and CTL4, as done by BMY and AZN. As a reminder, Merck & Co. has recently announced that FDA has accepted the filing for their PDL1/chemo combo, but given that the filing is based on a small dataset, it's not ensured that will be approved. Thus, it's too early to pick up the winner, but it's certain that chemo/combo approach will be cheaper than PD1/CTL4 one, thus if AstraZeneca and BMY will not report outstanding results, their opportunity in the 1st NSCLC could be smaller than expected.
In summary, in 2017, we will have clarity on the potential for AstraZeneca in the immunotherapy space, but I would not rule out some negative surprise, given that there are a lot of unknowns and uncertainties after the recent news flow in the space.
On 2nd February 2017, AstraZeneca will announce its guidance for FY 2017, which is expected to show further sales and profitability decline. But with shares near their lows, the key for AstraZeneca to outperform in 2017 will be related to the ability of the company to deliver on its pipeline, especially in oncology. Unfortunately I see too many issues and uncertainties behind AstraZeneca's approach to the I/O space and I would not chase the company at current level.
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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