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Morningstar | Roche's Pipeline Update Highlights Path to Growth in the Face of Biosimilars; Shares Undervalued

Roche hosted a late-stage pipeline event on Sept. 13 that reinforced our conviction surrounding the potential of Roche's upcoming drug launches and the firm's ability to grow through biosimilar pressure. This wide moat drug firm remains significantly undervalued at recent prices, and we're maintaining our CHF 337 per share/$42 per ADR fair value estimate. While Herceptin and Rituxan biosimilar competition will only intensify going forward, particularly as both should face biosimilars in the U.S. in 2019, we think the firm's remaining portfolio and pipeline will allow 4% average top-line growth through 2022, ahead of consensus. We expect additional Tecentriq lung cancer data by Sept. 25 from the World Conference on Lung Cancer, with details from Impower 133 (PFS and OS benefit over chemo alone in small cell lung cancer) and Impower 132 (PFS benefit over chemo alone in non-squamous non-small cell lung cancer). In addition, we believe Tecentriq's differentiating data in combination with Avastin will be key to uptake in lung, renal, and liver cancers, and other immuno-oncology firms are well behind in studying EGFR-mutant lung cancer patients; Merck's Keytruda just entered phase 3 in this population in June with a chemo combination regimen.

At the event, Roche outlined a conservative case for biosimilar pressure to Herceptin, Avastin, and Rituxan, amounting to a CHF 10 billion hit to the top line by 2022 that needs to be countered with growth from the firm's newer drugs and pipeline. This is slightly more aggressive than our own assumptions, which call for a CHF 8 billion hit over this time frame (both estimates are netted against expected gains in Roche's HER2 franchise beyond Herceptin, particularly Perjeta). While some reform should boost U.S. biosimilar uptake beginning in 2019, such as Medicare Advantage step therapy, we think several unlikely regulatory and legal changes (such as moving medical benefit drugs to a pharmacy benefit system, or moving rapidly to a competitive acquisition program in Medicare Part B) would need to go against Roche for the firm's conservative projections to come to fruition. For more on our policy analysis, please see our Healthcare Observer, "U.S. Drug Pricing Reforms Weigh on Valuations, but Moats Look Secure and Drug and Biotech Industries Look Undervalued."

We believe Roche can more than offset the hit from biosimilars with its current portfolio, and we see additional upside from the pipeline. Among approved drugs, we remain more bullish than consensus on Venclexta (AML approval and first-line data in CLL expected this year), Gazyva (increasingly the standard of care in first-line follicular lymphoma, over Roche's Rituxan), and Tecentriq (key Avastin combination should gain approval in December in lung cancer), and we agree with strong consensus expectations for MS drug Ocrevus (launching in Europe) and hemophilia A drug Hemlibra (poised to gain expanded approval next month).

In the pipeline, we incorporate roughly CHF 3 billion more sales in 2022 than consensus, which stems from several late-stage programs but is most influenced by new flu drug baloxavir marboxil (U.S. approval expected in December), novel neurology therapies like spinal muscular atrophy drug risdiplam (filing 2019) and Alzheimer's disease therapies gantenerumab (in Phase 3) and crenezumab (data 2020), and cancer therapies like breast/prostate cancer drug ipatasertib (in Phase 3) and lymphoma drug polatuzumab vedotin (to be filed in aggressive lymphoma later this year). Roche also highlighted promising early data for Huntington's disease drug RG6042 (entering phase 3 this year) and lymphoma therapy mosunetuzumab (early data being presented in December), and we've added both drugs to our valuation model.