How Sensitive Is Roche To Changes In R&D Expenses?
We estimate that Roche’s (NASDAQ:RHHBY) R&D expenses will grow in low single digit in 2018. However, we don’t expect any significant changes in R&D expenditure as a percentage of Roche’s gross profits. In general, many large pharmaceutical firms are becoming more financially disciplined in order to protect their earnings which are under threat due to patent expiries for key drugs. Roche will lose its patent exclusivity for its top selling drugs – Avastin, Herceptin, and MabThera/Rituxan – within the next 18 months or so. While Roche has a promising portfolio of new drugs, which may offset the revenue declines that are expected from the loss of patent exclusivity in the above three drugs, we expect the company to be prudent about its R&D spending. We have created an interactive dashboard on Roche’s sensitivity to changes in its R&D expenses. Note that you can adjust the R&D drivers, and see the impact on Roche’s overall valuation and price estimate. Below are some of the charts and data from the interactive dashboard.
Our price estimate of $36 for Roche implies a premium of over 25% to the market.
Expect R&D Expenses To See Modest Growth In 2018
We forecast Roche’s R&D expenditures separately for its Pharmaceuticals and Diagnostics segments. Pharmaceuticals R&D expenditures as a percentage of pharma gross profit has roughly been in the range of 24% to 25% over the past few years. We don’t expect any change in this range, and estimate it to be 24.8% in 2018. Looking at Diagnostics R&D expenditures as a percentage of diagnostics gross profit, the figure has increased from 12.2% in 2010 to 16.6% in 2017. However, it has been around 16% over the last three years, and we expect it to remain around similar levels in 2018. Given that we forecast an increase in Roche’s overall gross profits for 2018, driven by higher revenues, this should translate into overall R&D expenditures of nearly $10 billion, reflecting a 3% rise over the prior year period. It should be noted that we estimate an 80% gross profit margin for Roche’s pharmaceuticals business, and roughly 54% for its Diagnostic business, which are in line with the historical averages.
Impact of Change In R&D Expense On Roche’s Valuation
Of late, several pharmaceutical companies, including Roche, have been focusing on a few specific therapeutic areas such as oncology. This is expected to streamline expenses and optimize R&D spending. However, developing and bringing a new drug to the market is a long process involving several phases including identifying the compound and clinical trials, which is costly and can last for several years. With many drugs facing patent expiry in the next few years, Roche has been investing prudently to grow its pharmaceutical pipeline, and this trend is likely to continue, at least in the near term. This could result in higher R&D spending as well. A 2.5% increase in R&D expenditures as a percentage of gross profit for both segments would translate into an approximately 5% decline in Roche’s valuation and stock price estimate (assuming no near-term boost to revenues), as shown in the scenario on our interactive dashboard.
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