Should You Buy Roche At $43?

by Trefis Team
Roche Holdings
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Roche’s ADR (OTCMKTS: RHHBY) lost more than 15% – dropping from $41 at the beginning of the year to below $35 in late March – then spiked over 20% to around $43 now. That means it has fully recovered to the levels where it started the year.

Why? 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 helped the markets stage a strong recovery. Investors are now expecting a quicker economic rebound, which will bode well for Roche. In addition, the company is seeing an increase in Diagnostics sales, due to its Covid-19 testing, as well as continued market share gains for its newer drugs on the pharmaceuticals business side.

But is this all there is to the story?

Not quite. Despite the recent rally, Trefis estimates Roche’s Valuation at about $50 per share, roughly 15% above the current market price based on two key opportunities and a risk.

The first opportunity we see is to Roche’s Revenue growth over the coming years. With the economies gradually opening up and lockdown restrictions being lifted in several cities, the healthcare institutions have begun attending to elective surgeries, which were deferred earlier. This means a gradual increase in hospital visits, number of procedures performed, and higher number of prescriptions issued, boding well for Roche. While the company’s sales from older drugs, such as Herceptin, Avastin, and Rituxan, will likely decline as they now face biosimilar competition, Roche’s relatively new drugs – Tecentriq, Perjeta, Ocrevus, and Kadcyla, among others  – are gaining market share, and they will likely more than offset that decline, resulting in steady revenue growth over the coming years. Looking at the Diagnostics business, the sales are expected to grow over the coming years, led by the company’s Covid-19 test. Roche’s two devices ~ cobas 6800 and cobas 8800 received FDA approval on March 13 for testing the coronavirus.

The second key opportunity stems from Roche’s valuation multiple compared to its peers. The stock now trades at 17x its projected 2020 adjusted earnings per share of about $2.51. In comparison, to earn close to $2.50 per year from a bank, you’d have to deposit about $250 in a savings account today (assuming 1% interest rate), so about 100x desired earnings. At Roche’s current share price of roughly $43, we are talking about a P/E multiple of around 17x based on expected 2020 adjusted earnings of $2.51, slightly higher than the levels of 16x seen in 2019. And we think a figure closer to 20x will be appropriate. While the 20x number appears high compared to levels seen over the recent years, it is due to the fact that 2020 EPS will be impacted due to Covid-19. The estimated adjusted EPS of $2.51 in 2020 compares with $2.54 and $2.31 figures seen in 2019 and 2018 respectively. With Roche’s new drugs expected to see strong growth over the coming years, clubbed with margin expansion due to better product mix and cost cutting measures, this will result in steady earnings growth over the coming years. Also, Roche’s P/E multiple is lower compared to some of its peers, such as Johnson & Johnson which currently trades at 19x its projected 2020 earnings, while Eli Lilly trades at 24x.

That said, there is a risk to the company’s business.

Given the current Covid-19 pandemic, several types of elective surgeries were postponed in the first half of the year, and people avoided non-emergency visits to hospitals, impacting the company’s diagnostics as well as pharmaceuticals businesses. Though the Covid-19 tests has helped its diagnostics business, the company in its recent earnings conference call stated that it expects a $4.7 billion impact from biosimilars and Covid-19 on the overall business in 2020. While Covid-19 related impact is expected to be short-lived, the company will have to deal with the biosimilar competition for its blockbuster drugs, Avastin, Herceptin, and Rituxan over the coming years.

Despite that, the situation is changing on the ground with an increase in number of procedures performed as the economies open up and result in a likely increase in the number of prescriptions issued in the second half of the year. As far as biosimilar competition is concerned, the incremental growth in the company’s relatively newer drugs is expected to more than offset such decline over the coming years. Overall, the rebound in economic growth and its timing hinge on the broader containment of the coronavirus spread. Our dashboard forecasting U.S. Covid-19 cases with cross-country comparisons analyzes expected recovery time-frames and possible spread of the virus. Further, our dashboard -28% Coronavirus crash vs. 4 Historic crashes builds a complete macro picture. The complete set of coronavirus impact and timing analyses is available here. For Roche the key trend to watch out for will be the incremental sales of its new drugs in Q3, as they continue to gain market share and help the company offset the decline expected from biosimilar competition.

While Roche stock looks like it can gain more, AbbVie appears to have found a way to reduce its reliance on Humira, courtesy of the Allergan acquisition and expansion of its new drugs.

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