After a 19% fall year-to-date, at the current levels, we believe Roche’s ADR (OTCMKTS: RHHBY) is undervalued. RHHBY stock fell from $52 in early January to $42 now. The YTD -19% return for RHHBY marks an in-line performance with -21% returns for the broader S&P500 index.
Looking at the longer term, RHHBY stock is up only 3% from levels seen in late 2019. This marks an underperformance compared to some of its peers and the broader markets, with Johnson & Johnson stock rising 22%, Pfizer stock rising 41%, Merck stock up 5%, and the S&P 500 index rising 17% over the same period.
This 3% rise for RHHBY stock since late 2019 can be attributed to 1. Roche’s earnings, which rose 7.0% to $2.72 in 2021, compared to $2.54 in 2019, on a per share and adjusted basis, partly offset by 2. the company’s P/E ratio, which fell 4.1% to 15.3x trailing adjusted earnings currently, from 16.0x. The earnings growth above can be attributed to higher revenues, partly offset by net margin contraction, as discussed below.
Roche’s revenue grew 12.4% to $72.4 billion in 2021, compared to $64.4 billion in 2019, partly driven by higher demand for Covid-19 testing since the beginning of the pandemic. The company’s diagnostics business benefited from higher demand for Covid-19 testing, with its sales surging 49% between 2019 and 2021. It also sells Ronapreve – a treatment for Covid-19, developed by Regeneron and distributed by Roche outside the U.S. The Covid-19-related products accounted for $7 billion of the $72 billion sales for Roche in 2021.
The company also benefited from the continued uptick of its relatively new drugs, including Perjeta, Kadcyla, Alecensa, Tecentriq, Actemra, Hemlibra, and Ocrevus. These drugs combined garnered $24.4 billion in sales in 2021, reflecting a 21% y-o-y growth. These drugs are expected to be the key growth drivers for Roche as it battles with biosimilar competition for its top-selling drugs – Avastin, Herceptin, and Rituxan – which have seen their combined sales fall a significant 54% to $9.1 billion in 2021, compared to $19.8 billion in 2019.
As we look forward, Roche will continue to face headwinds from biosimilar competition for its relatively older drugs. Although Roche will likely see a pickup in routine diagnostics over the coming quarters, it is unlikely to offset the expected decline from Covid-19-related testing. These factors will probably weigh on the company’s top-line growth in the coming years.
Looking at the company’s latest quarterly results, its top-line grew 11% on a constant exchange rate basis, with the diagnostics business seeing a 24% rise and pharmaceuticals up 6%. A surge in Covid-19 cases aided the company’s diagnostics business in Q1, with an increased demand for its testing.
Some of Roche’s clinical trial findings weren’t favorable this year. Its Alzheimer’s treatment – Crenezumab – failed to slow or prevent cognitive decline in Alzheimer’s patients. The company’s immunotherapy – Tiragolumab – could not meet its endpoint in a late-stage clinical trial for a lung cancer subtype. If successful, both of the above drugs would have been potential blockbuster drugs. Roche will continue to examine Tiragolumab while it has another Alzheimer’s treatment – Gantenerumab – in the pipeline.
Looking forward, Roche will continue to face headwinds from biosimilar competition and likely face a sales decline from lower demand for Covid-19 testing. A slowdown in global economic growth due to rising inflation is not great news either. RHHBY stock also faces headwinds from the current weakness in broader markets. The S&P500 has now entered the bear market territory with rising concerns of slowing economic growth given the high inflation, Fed action, and supply chain disruptions.
However, most of these factors appear to have already been priced in by the investors, given the decline in RHHBY stock. We estimate Roche’s valuation to be $59 per share, reflecting over a 40% upside from its current market price of $42, implying that investors are likely to be better off buying RHHBY stock in the recent dip for solid gains in the long-term. At its current levels, RHHBY stock is trading at just 15x forward adjusted earnings, compared to the last three-year average of 17x, making the stock attractive from a valuation point of view.
While RHHBY stock has more room for growth, it is helpful to see other valuable comparisons for companies across industries at Peer Comparisons. Furthermore, the Covid-19 crisis has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for IDEXX Laboratories vs. Entegris.
|S&P 500 Return||0%||-21%||69%|
|Trefis Multi-Strategy Portfolio||1%||-26%||193%|
 Month-to-date and year-to-date as of 7/1/2022
 Cumulative total returns since the end of 2016