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Morningstar | Celgene's Shares and Pipeline Significantly Undervalued Following In-Line 3Q

Celgene reported third-quarter results that were in line with our expectations and reaffirmed 2020 guidance, and we're not making any significant changes to our valuation model. The shares trade at a steep discount to our $116 fair value estimate, which we think is driven by a combination of a fixation on Revlimid declines, failure to incorporate the potential of the firm's late-stage pipeline, and general U.S. pricing pressure fears in the branded drug space. We assign key pipeline drugs (including liso-cel, bb2121, ozanimod, luspatercept, CC-486, and next-generation IMiDs) higher sales projections than consensus, which more than counters our bearish view on Revlimid in our valuation. These products drive a stronger, more diversified foundation for the firm going forward and support our narrow moat and positive trend ratings. With three drug filings through the first half of 2019 (luspatercept, fedratinib, and ozanimod) as well as two launches poised for 2020 (liso-cel and bb2121), we think headwinds, ranging from Revlimid generics beginning in 2022 to changes to Medicare Part D polices starting in 2019, are manageable. At the annual meeting of the American Society of Hematology in December, Celgene will have data for luspatercept (details for the positive phase 3 studies in MDS and beta-thalassemia), Revlimid (in follicular lymphoma), liso-cel (chronic lymphocytic leukemia), and JCARH125 (multiple myeloma).

We think Celgene could see a 1.9% earnings hit in 2019 from the increase in the firm's donut hole obligation in Medicare Part D from 50% to 70%, making it the most exposed among big pharma and big biotech names in our coverage universe, as we outlined in our Healthcare Observer, "U.S. Drug Pricing Reforms Weigh on Valuations, but Moats Look Secure and Drug and Biotech Industries Look Undervalued." For our deep dive into Celgene's pipeline prospects and assessment of the impact of Revlimid's upcoming patent expiration on the firm's moat and cash flows, please see "Celgene: Winning the Fight to Preserve a Post-Revlimid Moat."

While liso-cel's launch is now pushed back a year in our model, ozanimod's refiling looks on track, and we're not making any significant changes to our pipeline assumptions. Celgene management clarified that ongoing drug-drug interaction studies for ozanimod are not required to be completed before resubmitting the drug with the Food and Drug Administration, and that the firm is still on track for a refiling in the first quarter of 2019. We expect Celgene is hoping to add results from these trials to ozanimod's label in an effort to further differentiate the drug from Novartis' Gilenya, which has warnings about heart-related side effects on its label and is contraindicated for patients with a history of certain cardiovascular problems. We have also moved the potential launch for liso-cel in lymphoma from 2019 to 2020, as Celgene now expects to file on nine-month data from the ongoing Transcend study, rather than six-month data. Given the drug's third-to-market position among CD19-targeted CAR-T therapies in lymphoma, we think this is a smart move and could give Celgene a better shot at differentiation from Gilead's Yescarta and Novartis' Kymriah.

We also think Celgene is taking logical steps to expand Otezla's market reach, given the current and potential future competitive landscape. Otezla had strong performance (40% growth) in the third quarter based on solid global demand, and management slightly raised guidance for 2018 on stronger-than-expected Otezla performance. Otezla guidance now stands at $1.6 billion versus $1.5 billion previously, and new guidance is closer to our own estimate around $1.6 billion. While a once-daily formulation is no longer in development, Celgene is starting several large trials to support use of Otezla in milder forms of the disease. This could help defend Otezla against competitors like Bristol's BMS-986165, which is in phase 3 against Otezla (data expected in 2020) in the moderate to severe psoriasis setting.