VALUATION HIGHLIGHTS

1. Other Therapeutic Drugs constitute 34% of the Trefis price estimate for Roche Holdings's stock.
2. Oncology Drugs constitute 27% of the Trefis price estimate for Roche Holdings's stock.
3. In Vitro Diagnostics constitute 16% of the Trefis price estimate for Roche Holdings's stock.

WHAT HAS CHANGED?

1. Roche's ADR Performance
   • RHHBY stock has suffered a sharp decline of 35% from levels of $45 in early January 2021 to around $30 now (mid-April 2024), vs. an increase of about 35% for the S&P 500 over this roughly 3-year period.
   • Notably, RHHBY stock has underperformed the broader market in each of the last 3 years. Returns for the stock were 18% in 2021, -24% in 2022, and -7% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 - indicating that RHHBY underperformed the S&P in 2021, 2022 and 2023.

2. Roche's 2023 Results
   • Roche garnered CHF 58.7 billion in 2023 sales, reflecting a 7% y-o-y decline, led by a 20% decline in Diagnostics sales, while Pharmaceuticals sales were down 4%. Roche reported core earnings of CHF 18.57 per share versus CHF 20.30 in 2022.

3. Impact of Coronavirus Crisis On Roche's ADR
   • Roche's ADR lost more than 12%, dropping from $41 at the beginning of 2020 to below $36 in late March 2020. It then spiked 47% to around $54 in April 2022 before falling to $30 currently (mid-April 2024). That means RHHBY ADR is still below its pre-pandemic levels.

     While the COVID-19 outbreak and associated lockdowns resulted in an uncertain outlook for the broader markets, the multi-billion-dollar Fed stimulus announced in late March 2020 helped the markets stage a strong recovery. Investors expected a quicker economic rebound. In addition, Roche's COVID-19 tests, as well as strong growth in sales of new drugs, have boded well for its sales growth.

     However, a high inflationary environment, rising interest rates, and fears of a recession have spooked the markets. Roche, in particular, faces biosimilar competition for some of its blockbuster drugs as well as a meaningful decline in sales of its Covid-19-related products. These factors have weighed on Roche's ADR in the recent past.

4. Loss of Patent Exclusivity
   • Over the last few years, some of Roche's key drugs, including Rituxan, Avastin, and Herceptin, have lost their patent protection. These are blockbuster drugs with sales of around $6 billion each in 2018. But given the loss of market exclusivity, the combined sales declined from $19.4 billion in 2018 to $9.1 billion in 2021. This trend will likely continue in the near term. Also, some of the other pharmaceutical companies have already developed biosimilars for these three drugs, likely resulting in lower sales for Roche going forward.

5. New Drugs So Far Offsetting The Decline In The Sales of Older Drugs
   • As stated above, Roche is facing biosimilar competition for some of its blockbuster drugs. However, the company's new drugs are expected to offset the decline in older drugs.

6. Ocrevus Driving The Growth
   • Ocrevus is used for the treatment of relapsing and primary progressive forms of multiple sclerosis. The drug has been on a strong run in the recent past, and the revenues have grown by a whopping 7x to $6.4 billion in 2022, compared to around $856 million in 2017. Ocrevus will likely be a key player in the multiple sclerosis segment and could garner as much as $8 billion in peak sales, in our view.

7. Late Stage Pipeline
   • Roche's pipeline is quite strong as it continues to invest in the growing area of immuno-oncology. Looking at the programs under phase 3 trials, we find that the company is giving a strong push to Kadcyla and Tecentriq in oncology. In addition, the company has a stronghold in the neuroscience area. We estimate the combined potential peak sales of phase 3 drugs to be over $20 billion. After a strong run-up in the past few years, Roche's fast-growing pharma business could face the risk of a slowdown. Therefore, the company is banking on these phase 3 pipeline drugs to drive growth going forward.

POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE

Below are some key drivers of Roche's value that present opportunities for upside or downside to the current Trefis price estimate:

Biosimilar price competition intensifies

• Revenues from Oncology Drugs: The competition from biosimilars is increasing. Needless to say, a big chunk of Roche's revenues comes from biologics. This puts the company in a vulnerable position should the competition from biosimilars intensify in the next few years. Currently, our forecast assumes that biosimilars will be priced roughly 30% below the regular prices for patented biologics and that Roche will be able to defend its primary franchises to some extent (Rituxan and Herceptin) by targeting adjuvant therapies. But it is plausible that we are underestimating the future impact of biosimilars and overplaying Roche's competitive position, which is very strong right now. The evolving competition may bring the prices further down. If the discounts eventually extend to as much as 60%-70%, Roche can potentially lose $5 billion in annual oncology sales by 2027, which would imply a downside of about 10%.

Phase 3 pipeline doesn't bode well

• Oncology Drugs Revenues and Neuroscience,Metabolism and Other Drugs Revenues: Our valuation of phase 3 drugs incorporates a 50% probability of these drugs reaching the commercial launch stage, and therefore, our revenue forecast includes probability-adjusted revenue for these drugs. Neuroscience and oncology drugs together account for 75% of our price estimate for Roche. However, there were cases even in the recent past where the phase 3 trials did not meet their endpoint. If such issues plague Roche's phase 3 trials of oncology and neuroscience, and the drugs don't gain FDA approval, it would imply a 15% downside to our price estimate.

Phase 3 pipeline bolsters sales growth

• Oncology Drugs Revenues and Neuroscience, Metabolism and Other Drugs Revenues: Roche's pipeline is quite strong as it continues to invest in the growing area of immuno-oncology. Looking at the programs under phase 3 trials, we find that the company is giving a strong push to Kadcyla and Tecentriq in oncology. In addition, the company has a stronghold in the neuroscience area. We estimate the combined potential peak sales of phase 3 drugs to be about $20 billion. However, our valuation reflects probability-adjusted revenues assuming a 50% probability of phase 3 drugs reaching the commercial launch stage. However, if all phase 3 oncology and neuroscience drugs are approved within the next 3-4 years, it would imply over 15% upside to our price estimate for Roche due to accounting for 100% of their sales. In other words, the uncertainty around the approval of these drugs will be eliminated, implying lower risk and higher valuation.
  
  

  BUSINESS SUMMARY

  
  Established in 1896 and headquartered in Basel, Roche is a healthcare company with a global presence. The firm operates in two main segments: Pharmaceuticals and Diagnostics. The pharmaceutical segment produces drugs in various therapeutic segments, primarily Oncology (cancer drugs), Autoimmune, Virology, Respiratory, Metabolism, Renal Anemia, and Ophthalmology. Roche has the largest oncology drug market share in the world with a range of successful products such as Avastin, Herceptin, and Mabthera/Rituxan.
  The company also has a leading market position in in-vitro diagnostics. It reports its in vitro diagnostics segment into four categories: Centralized And Point of Care Solutions, Tissue Diagnostics, Molecular Diagnostics, and Diabetes Care. Some of its best-selling products are CoaguChek, Accu-Chek, Immunoassays, blood glucose monitoring systems, advanced tissue staining, and tests for HIV and Hepatitis B & C. Roche plans to acquire companies in genetic sequencing to strengthen its diagnostics division. Roche operates through its subsidiaries including Genentech and Ventana in the U.S. and Chugai Pharmaceuticals in Japan.
  

  SOURCES OF VALUE

  
  Roche manufactures some of the world's best-selling drugs, including Avastin, Herceptin, and Mabthera/ Rituxan. Its oncology segment is the most formidable in the world with a host of pipeline drugs ready to make up for lost revenue after patent expiries. The oncology segment contributes around 31% of the company's value according to our estimates, followed by other drugs at 26%.
  

  Oncology to see slower growth

  
  Roche's personalized healthcare and focus on cancer treatment have made it a leader in the oncology segment. It has a dedicated R&D and a range of pipeline drugs in addition to its highly successful products already available in the market. Most of its pipeline drugs could potentially be very commercially successful and would help the company maintain its market leadership position. That said, the biosimilar competition for its older drugs will weigh on the segment revenue growth over the next few years.
  

  KEY TRENDS

  
  

  Strong demand for Ocrevus

  Ocrevus is used for the treatment of relapsing and primary progressive forms of multiple sclerosis. The drug has been on a strong run in the recent past, and the revenues have grown over 6x to $6.5 billion in 2022, compared to just $856 million in 2017. Ocrevus will likely be a key player in the multiple sclerosis segment and could garner as much as $8 billion in peak sales, in our view.
  

  Rapidly growing emerging markets

  Per capita income levels in many emerging markets are rising rapidly, which provides an immense opportunity for growth in these markets. Also, new studies and increased access to information have led to rising health consciousness in these markets. However, many of these markets have less effective patent laws, which can ultimately limit Roche's growth potential there.
  

  Growing threat of generic products and biosimilars

  The fast-growing pharma markets in emerging economies - referred to as the 'Pharmerging' economies - have the capability and technical prowess to manufacture generic versions of blockbuster drugs. These generic drugs are often sold at prices that are substantially cheaper than their branded counterparts, thereby severely affecting big pharma's ability to generate profits in the long run. Roche's drugs could face potential threat from biosimilars in the future, which are generic versions of biologics.
  Historically, biologics remained well protected due to the lack of appropriate approval guidelines. Biosimilars are comparable to generics in the sense that they are approved substitutes for specific bio-engineered therapies or biologics. However, while generics are exact chemical copies of the small molecule therapies they replace, biosimilars include only the therapeutically active portion of large molecules biologics. Biosimilars are large molecule therapies that are generated through biological processes in so-called bioreactors containing specialized ecosystems. As such, they are harder to manufacture and require a greater deal of technical expertise. However, recent industry developments suggest that more biosimilars are likely to be approved going forward.
  

  Global healthcare reforms

  Governments around the world have been undertaking significant healthcare reform programs. Some of these programs could effectively cap drug pricing with rebates and other mechanisms.