This is an excerpt from a blog published earlier today: Stocks, Bonds & Politics: Sold 100 of 200 DPG at $20.74/Sold Roth IRA: 100 PNNT at $9.53 and 70 ARCC at $16.87-Balancing Risks and Rewards/Bought 50 RHHBY at $32.99/Bailed on SD 2020 Bond-Sold at 74.69-Bought at 65
I am justifying this purchase primarily under my Dividend Growth Strategy and for diversification purposes.
I discuss the dividend growth strategy in a SA Instablog and in a 2010 blog:
The dividend growth strategy was developed decades ago by others and is hardly original to me.
The diversification strategy involves in part ownership of assets priced in certain foreign currencies.
As a U.S. citizen, most of my assets are priced in USDs.
The purchase of the USD priced Roche ADR shares will provide me more exposure to the Swiss Franc (hereinafter "CHF).
My largest exposure to CHF priced assets is through the Swiss Helvetia Fund (NYSE:SWZ). My most recent purchase was 172+ shares bought with the annual dividend paid a few weeks ago. CEFConnect Page for SWZ Roche had a 12.13% weighting in that fund as of 1/31/15: Swiss Helvetia Fund
There are several reasons for diversification into assets priced in certain developed foreign currencies. The most important is my personal views about the U.S. government's ability to engage in responsible spending and tax policies now or at anytime in the foreseeable future.
I anticipate a continued parabolic rise in the nation's debt that will be exacerbated substantially by a rise in interest rates. A some point in the not too distant future, the U.S. government's interest cost will exceed $1 trillion per year, or more than the total debt of the U.S. prior to 1980. Government-The Debt to the Penny Government - Interest Expense on the Debt Outstanding In my opinion, which is what I have to implement when making investment decisions, a major fiscal train wreck is likely within 15 to 25 years, possibly precipitated by a series of failed treasury auctions.
Bought 50 Roche (OTCQX:RHHBY) at $32.99 (see Disclaimer):
Snapshot of Trade:
The ordinary shares closed at CHF 245 -.80. on the day of my purchase.
1 ADR = .125 Ordinary Shares
.125 Ordinary Shares= CHF 30.625
Conversion Value for 1 ADR: $33.0474
Company Description: Roche Holding AG ADS (OTCQX:RHHBY) is one of the world's largest pharmaceutical and diagnostic companies. The company is based in Switzerland with a significant presence in the U.S. through its U.S. wholly owned subsidiary Genentech.
Roche will be adversely impacted in its reported revenues and sales due to the rise in the Swiss Franc. About 18% of Roche's costs are in CHFs, and the company has no plans to move existing operations to lower cost countries. Reuters A continuation of the CHF at its current level is anticipated to reduce core earnings by 9%.
Roche shares have declined over the past year in part due to several pipeline drug failures. New drug treatments for Alzheimer's disease, schizophrenia and two other drug candidates (ALECARDIO aleglitazar and the lung cancer drug Onartuzumab) due to safety and/or efficacy issues. As noted in the prior link regarding the lung cancer drug, the unexpected Phase III may be reflect a poor trial study design.
In 2009, Roche made an important acquisition by agreeing to acquire the remaining 44% of Genentech shares that it did not own for $95 per share or $46.8 B. Roche had acquired majority control of Genentech in 1990 for $2.1B. Genentech is now a wholly owned Roche subsidiary. Bloomberg
Some of the important Genentech drug discoveries include the following cancer drugs, many of which are well known to non-stock investors:
Gazya: chronic lymphocytic leukemia,
Herceptin: breast cancer,
Tarceva: Non-Small Cell Lung Cancer and
Zelboraf: (metastatic melanoma)
Other Genentech discoveries include Lucentis (wet macular degeneration), Tamiflu, and Xolair (allergies)
Lucentis is sometimes to referred to as a cosmetic version of the Avastin molecule. Lucentis is about 50 times more expensive and both drugs cost about the same to manufacture. Eye doctors will often use avastin off-label to treat wet macular degeneration rather than Lucentis. It may be more profitable for the doctors to use Lucentis however. As noted in the preceding linked article published by the Washington Post, Medicare has to pay for both drugs. Lucentis has been approved for the treatment of wet macular while the company has refused the FDA's entreaties to seek approval for Avastin's use in that treatment. While I do not remember the details, Avastin was approved as a cancer treatment by the FDA, and its effectiveness was due to cutting off the blood supply growth to tumors. Patients who were taking the drug for cancer noted an improvement in their vision. Some eye doctors started to inject Avastin directly into the eye to shut down or reduce abnormal blood vessel bleeding that was destroying the macular (the center of the retina) and causing loss of eyesight.
Roche currently does not expect biosimilar competition for its Herceptin product before 2017.
A new drug for wet macular degeneration, Eylea, has been approved by the FDA.
I took a snapshot of drug sales by product to highlight Genentech's importance to Roche:
Page 12: Roche 2014 Financial Report.pdf
Sales of Pegasys, an approved treatment for hepatitis B and C, are declining due to competition from new treatments. (Peginterferon alfa-2a)
About 75% of Roche's revenues come from biologics which are not chemically synthesized drugs and are consequently less susceptible to traditional generic competition. Biologics are manufactured "in a living system such as microorganism, or plant or animal cells".
Roche's in vitro diagnostic business has about a 20% global market share.
The annualized total return for the ADR shares was 13.63% starting on 8/20/2003 through 2/14/15. Total Return
I also read several recent press releases including the following, with the first probably being the most important:
Chart: RHHBY is currently selling below its 50, 100 and 200 day simple moving average lines. RHHBY Interactive Stock Chart
As shown in that chart, the shares have been in dive mode since closing at $37.92 (12/1/14). The USD priced shares received a lift when the Swiss National Bank ended its Euro peg that immediately caused the CHF to rise in value against the Euro and the USD. The rise in the value of the CHF flows through into the pricing of the USD priced ADR. However, due to the decline in the ordinary shares, this currency related gain was muted and short lived, as the ordinary shares priced in CHFs declined in value as shown in this one year comparison chart:
One Year Comparison Chart CH:ROG (Blue Line) vs. RHHBY
The Swiss stock market declined significantly in value when the Swiss National Bank ended its Euro peg. The stronger Swiss Franc will have a negative impact on reported earnings. That decision was announced on 1/15/15. The currency related rise in the ADR shares was higher than the percentage decline in the ordinary shares which is why the RHHBY line chart goes up that day as the ordinary share price plunged in value.
Dividend History: I could only find at Roche's website a chart depicting its dividend history since 2002:
I consequently do not know the dividend amounts prior to 2002.
In its "Investor Update" dated 1/28/15, Roche states that is board approved a 3% dividend increase to 8 Swiss Francs, the "28th consecutive year of dividend growth".
The chart does, however, show a significant slowing in the dividend growth rate. It looks like about 1.5CHF per share was paid in 2002. The percentage increase to 8 CHFs would be huge at 433.33% over a 13 year period, Calculate Percent Increase, but the last increase was only 3%.
Like many European companies, Roche pays its dividend annually.
The 8 Swiss France for the ordinary shares translates in a dividend of 1 CHF per ADR share.
The value of that dividend will be determined when the actual conversion from CHFs to USDs takes place. If the conversion occurred on 2/10/15, the date of my share purchase, the value would be about $1.0815. For purposes of illustration only, that dividend value would result in a dividend yield of about 3.28% at a total cost of $32.99 per share.
Switzerland's Withholding Tax:
Switzerland will withhold a 15% tax on that amount. When held in a taxable account, a U.S. taxpayer can recover all or part of a foreign dividend tax as explained in this Schwab article.
A taxpayer may run into a problem recovering all of the foreign taxes when the amount of foreign tax paid exceeds $300 for a single person and $600 for a married couple. A credit can be claimed up to those amounts without filing out a somewhat complex IRS form 1116. Accountants may not mind filling out that form since it just adds to the bill. It gives me a headache.
That form has to be filled out when claiming more than those limits as a credit. The form will limit the foreign tax credit "to the lesser of the amount of foreign tax paid or the U.S. tax liability on the same income". This would become relevant for a taxpayer who wants to claim more than the foregoing limits, but who is in a marginal tax rate of less than 15% when the foreign dividend income tax rate was 15%. I would emphasize that I am just giving a common sense explanation of the material contained in that Schwab document. I am certainly not a tax expert, and I am not giving anyone tax advice here. It is important, however, to at least grasp the essential elements explained in that Schwab article to make an informed investment decision when buying dividend paying foreign stocks.
Recent Earnings Report: I would generally describe the recent earnings report as unimpressive, which partly explains my relatively small initial purchase. For the full year, Roche reported core E.P.S. of CHF 14.29, missing the consensus estimate of CHF 14.7. On a constant currency basis, core E.P.S. and revenues advanced about 5% Y-O-Y. That number is expressed in the abbreviation CER (constant currency rates) in the following table:
Free cash flow decreased about -1% in 2014 to CHF5.322B. (pages 10 and 33)
Roche expects 2014 revenues to grow in the low-to-mid single digits based on constant exchange rates. Core earnings per share are targeted to grow faster at CER. Roche Press Release-"Roche delivers solid results in 2014"
Rationale: I would not be buying Roche stock without Genentech being in the fold. I simply have more confidence in the ability of Genentech researchers to discover new drugs, and the value of a drug company long term will be driven by internal innovation rather than the Pfizer approach to drug discovery.
I also want more exposure to assets priced in Swiss Francs without having to convert my USDs into CHFs. I may pursue that option in a few years, but I am content now in expanding my ownership of U.S. traded Swiss stocks whose value will be determined in part by the value of the CHF/USD exchange rate. I have far more confidence in the CHF as a store of value long term than the USD.
While Roche's dividend growth has slowed some, the company does have a long track of raising its dividend. The pace of future dividend increases will depend on drug discoveries rather than existing products.
There is a fairly robust pipeline of new drugs currently in trials or new use FDA filings for existing drugs: Roche-Pipeline and Pipeline Summary.pdf (new molecular entities at pages 79-81). However, I did not see a number of potential near term catalysts in the pipeline.
Risks: Based on the 2015 E.P.S. estimate of CHF 14.02, Bloomberg, the forward P/E is about 17.37 based on last Friday's closing price of CHF243.6. I view that number as being in the upper end of my fair value range for Roche. I would therefore anticipate slower capital appreciation unless the E.P.S. growth rate accelerates. Without the CER adjustment, the 2014 E.P.S. was CHF 14.29, virtually unchanged from the CHF14.27 reported in 2014.
The following is a more condensed table than the proceeding one:
I will focus on earnings and revenues expressed in constant currencies. Core E.P.S. grew only 5% in 2014 based on the constant exchange rate.
The recent pipeline failures calls into question Roche's ability to successfully discover new treatments that have both efficacy and safety.
Future Buys and Sells: Until I see better results in CER, I am not likely to buy more shares unless there is a price drop to below $30 without any material adverse event causing the decline.
I have a larger position in Novartis and have a far more favorable opinion of NVS than of Roche, though I do not find NVS shares attractive at over $100 per share. Dividend Growth Strategy: Novartis - South Gent | Seeking Alpha
Novartis owns about 53.3+M Roche shares: Roche - Major Shareholders
Disclosure: The author is long RHHBY, SWZ.
Additional disclosure: Disclaimer: I am not a financial advisor but simply an individual investor who has been managing my own money since I was a teenager. In this post, I am acting solely as a financial journalist focusing on my own investments. The information contained in this post is not intended to be a complete description or summary of all available data relevant to making an investment decision. Instead, I am merely expressing some of the reasons underlying the purchase or sell of securities. Nothing in this post is intended to constitute investment or legal advice or a recommendation to buy or to sell. All investors need to perform their own due diligence before making any financial decision which requires at a minimum reading original source material available at the SEC and elsewhere. Each investor needs to assess a potential investment taking into account their personal risk tolerances, goals and situational risks. I can only make that kind of assessment for myself and family members.