Within the world of Big Pharma, Roche (OTC:RHHBY) offers a pretty compelling mix. Not only does Roche have one of the strongest oncology platforms today, it also offers one of the deepest pipelines. The company's non-oncology pipeline is not as strong in volume, but could well make up for that in quality if a couple of high-risk trials go the right way. Roche's modest debt and large cash generation capability also raises the prospect of M&A as biotech valuations quickly become more reasonable.
Starting the year on the right foot
Like many European companies, Roche only offers detailed financial information at the midpoint and end of each year. Consequently, first and third quarter updates are useful largely for corroborating models and any clinical updates they may offer.
Roche is starting the year off reasonably well. Revenue rose 5% in constant currency terms, good for a 1% beat relative to the sell-side. Drug sales were up 4%, with the company's breast cancer franchise up 17% and contributing more than 15% of overall sales. Although Herceptin sales were not up all that much (up 3%), Perjeta and Kadcyla are off to strong starts. Sales of Xeloda and Pegasys were not surprisingly down by high teens percentages, as Xeloda has gone off-patent in the U.S. and Pegasys is being replaced by better hepatitis C regimens.
The diagnostics business showed a nice 7% jump this quarter, with Professional up 9% on a 12% improvement in immunoassay sales. Diabetes was up 5%, a surprisingly strong result given the 14% decline at Johnson & Johnson (NYSE:JNJ) this quarter.
Oncology continues to be the prime driver
Few pharma companies are as committed to a therapeutic area as Roche is to oncology. Investors are certainly looking forward to upcoming cancer meetings (like the May ASCO meeting) to hear more updates on Roche's PD-L1 as the company runs neck-and-neck with Merck (NYSE:MRK) and Bristol-Myers (NYSE:BMY) to get these new antibodies to the market. Roche has also now announced that it will be moving its PD-L1 drug into a Phase II study in bladder cancer.
There is a long list of compounds behind PD-L1, including follow-on studies for approved drugs like Kadcyla and Perjeta, where a phase 3 readout on the MARIANNE study in 1st-line HER2+ breast cancer should be available later this year. One of the strong positives to Roche's oncology pipeline is its depth and breadth. Roche has MEK inhibitors, PI3K inhibitors, AKT inhibitors, immune stimulators, and checkpoint inhibitors in its pipeline.
The reason that is important is that it seems likely that it's not going to matter so much who has the best PD-1/PD-L1 drugs between Merck, Bristol-Myers, and AstraZeneca, but who can come up with the most effective combination therapies. To that end, Roche and Bristol-Myers have exceptionally deep pipelines at least in terms of the number of therapeutic targets, while Merck's pipeline is much more limited and the company may have to resort more to partnering (and surrendering some of the economics).
Roche is also a tough rival for companies like Johnson & Johnson and Celgene in hematological malignancies. It's worth watching how JNJ's Imbruvica and Roche's Gazyva develop over the coming year or two.
What about the non-oncology pipeline?
Roche has positioned itself into an unusually high-risk/high-reward place with its non-oncology pipeline, as there is not much depth and many of the lead programs are high-risk, but could become blockbusters if the clinical data are good enough.
Roche will be presenting phase 2 data on crenezumab in Alzheimer's around mid-year, and the company announced it was starting an additional phase 3 study for gantenerumab in Alzheimer's. Roche also recently announced solid Phase II data on asthma drug lebrikuzumab and if this efficacy holds up in pivotal studies, it should be a solid rival to drugs from Glaxo, AstraZeneca, and Sanofi.
Programs in Alzheimers, depression, asthma, ulcerative colitis, and autism could have substantial payoffs down the road, but the odds of success are not particularly good. With that, it's worth asking if the company will take advantage of this recent pullback in the biotech sector to pursue deals that would expand and diversify its pipeline.
The bottom line
With a basically in-line result, I see little reason to make significant changes to my model. My fair value target of $38 is based upon long-term revenue growth of 4% to 5%, which is on the high end for the sector, and long-term cash flow growth of over 6%. While Roche spends more on R&D (as a percentage of sales) than any other large pharma, its low SG&A spending allows for good FCF generation.
Roche is a decent idea at these levels. Between a yield around 3% and a required return of 9% supporting that $38 fair value, Roche should continue to beat the market over the long term as it advances its pipeline. While not a get-rich-quick stock, it continues to look like a very good name to own in the sector.