From time to time worries crop up that Roche (RHHBY 1.64%) is going to lose hold of its top spot in oncology, biologics, and diagnostics. A closer look at the pipeline suggests that this company has reloaded for what could be a series of product launches over the next four years that could generate billions, if not tens of billions of dollars in new revenue.
Roche is certainly going to face competition, as Bristol-Myers Squibb (BMY 0.43%), Novartis (NVS 0.80%), and AstraZeneca (AZN 2.31%) won't just cede the oncology market to them. It is also true that Roche needs to diversify beyond oncology, and pipeline candidates in areas like Alzheimers, schizophrenia, depression, multiple sclerosis, and ulcerative colitis may accomplish exactly that. Given today's valuation and the prospect for numerous clinical data events that de-risk even more revenue and free cash flow in the next five years, Roche still looks like a name to consider buying.
Multiple Data Reads And Potentially Lucrative Launches
Outside of a deep Phase II pipeline, Roche also has numerous late-stage trial read-outs coming soon (2014). Roche should be reporting pivotal trial data from studies Kadcyla, MetMAb, and GA101 in multiple cancer types, as well as its GlyT-1 candidate in schizophrenia. All told, I estimate that Roche's current Phase III pipeline could deliver $10 billion in risk-adjusted peak sales, with launches spread out over the next five years. Should all of those trials read out, the actual peak sales contributions could be worth nearly twice that figure, as "risk-adjusted" peak sales factor in the odds of approval as a discounting mechanism.
Clearly that "risk-adjusted" part must be kept in mind. Pipeline candidates like GlyT-1 (schizophrenia), and ocreluzimab (multiple sclerosis) are less than 50/50 propositions in my opinion, and potential blockbusters like crenezumab in Alzheimers and mGlu in depression are even less likely to make it to market. Even so, the existence of over $15 billion in risk-adjusted sales in Phase II and Phase III development is nothing to ignore. I also believe that investors should keep an important detail about Roche's pipeline management in mind – unlike others (I'm thinking particularly of Lilly), Roche is quick to snuff out candidates early in development if the odds of eventual approval do not seem adequate.
M&A Isn't Likely To Be Flashy
Roche has had its name attached to numerous acquisition candidates over the last year or so, with rare disease specialist Alexion perhaps the most widely publicized rumor. Not only has management repeatedly said that they're not target deals on that scale, the company has instead been focusing on precisely the sort of incremental add-on development/licensing partnerships that management said they wanted to do.
In recent months, Roche has signed on with Polyphor (antibiotics) and Prothena (Parkinson's), and build up its oncology pipeline with Molecular Partners (DARPins) and immatics (TUMAPs). I feel the later two are significant, as it builds on some already significant immunotherapy assets under Roche's roof. Roche is looking to cover multiple bases in immunotherapy, from conjugated antibodies to checkpoint agents and vaccines.
As combo therapies could play a major role in future treatment protocols, this broad approach could ultimately propel Roche ahead of Bristol-Myers, Novartis, and Merck, which have more limited immunotherapy assets and research scale. AstraZeneca also has a pretty broad portfolio of immunotherapy assets (and a decent history in oncology), but its programs are early stage and more than three years behind those of Roche and Bristol-Myers.
Capital Decisions On The Way?
Roche is getting close to a point where its free cash flow will have the company back at its target leverage positions. Once that point is reached, Roche will be in a position to consider a higher dividend, a share buyback, or even more partnering and acquisition candidates. I do not be believe that the company is in any hurry to buy back Novartis's stake in the company, as Novartis wants a premium for those voting shares that Roche simply doesn't need to pay.
I also do not see the company doing much more in life sciences; Roche failed to acquire Illumina and Life Technologies, closed down 454, and reached an agreement with Pacific Biosciences for in vito diagnostics-related sequencing. Roche's diagnostic operations do not appear to need any significant capital allocations either, though I wouldn't mind seeing the company upgrade its hepatitis C testing capabilities ahead of what I expect to be a significant increase in that market.
The Bottom Line
I am looking for Roche to post long-term revenue growth of almost 4%, which is among the highest growth rates I see in the Big Pharma space. Certainly there is a real risk that trial failures or competition will cause Roche to fall short of that target, but it is likewise true that better-than-expected pipeline yields will offer upside. I also expect that the company's ongoing focus on high-value biologics and its cash-rich diagnostics franchise will support strong free cash flow margins, leading to free cash flow growth in the neighborhood of 6%.
Those growth rates work out to a fair value of nearly $72 per ADR. Coupled with the dividend that is good for double-digit expected returns in the stock, which is rather strong for the pharma market today. I continue to remain a satisfied Roche shareholder and I believe there is still sufficient value here to argue for buying the shares.
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