Roche ( RHHBY ) recently announced its Q1 2017 earnings. The results were in-line with our expectation and there was no significant movement in the stock. In essence, Roche's story remains the same. We stated in our pre-earnings note that we expect Roche's diagnostics division to see mid-single digit growth. As it turned out, the business grew 6% primarily driven by expansion in immunodiagnostics and point-of-care solutions. Most of this growth came from international markets. As far as the pharmaceutical business is concerned, Roche saw a moderate growth of 3% excluding the impact of exchange rates, which was again in-line with our expectation. Most of the incremental revenue was driven by the uptake of Tecentriq in the U.S., followed by expansion of Perjeta and Xolair. While Tecentriq and Perjeta are cancer drugs, Xolair is used for the treatment of Asthma. One of Roche's legacy cancer stalwarts, Rituxan, grew meaningfully in the first quarter. However, the other oncology blockbuster drug Avastin saw its sales shrink amid higher competition and pricing changes in Japan. While APHINITY trial results can help the growth of another legacy cancer drug, Herceptin, the reality is that these legacy behemoths - Avastin, Herceptin, and Rituxan - will soon face biosimilar competition. While Roche's efforts to defend its existing franchises are commendable, we think that investors should focus on the company's commitment to its pipeline and new launches. The new drug launches and their subsequent performance may act as triggers for the stock.
Our price estimate of $32 for Roche is in line with the market. We are reviewing our price estimate in light of recent earnings, and will update it shortly.
The Legacy Drug Problem
So here is the problem. Herceptin, Avastin, and Rituxan together accounted for nearly 50% of Roche's pharmaceutical revenue in 2016, totaling over $21 billion. However, two of these drugs have already lost their EU patent exclusivity, and another will lose it next year. In addition, they'll all lose their patent protection in the U.S. in the next couple of years. As a result, we expect these drugs to lose nearly $4 billion in annual sales by 2020, and nearly $10 billion by 2023 as biosimilars hit the market. A Bloomberg survey suggests a loss of nearly $6-$7 billion in annual sales by 2021. Needless to say, there is a big gap that Roche must fill in the next 6 years. Rituxan is growing but EU approval of Celltrion's biosimilar version, which is likely to be used for leukemia, lymphoma, and rheumatoid arthritis, is going to put a dent in sales going forward. Additionally, Novartis' biosimilar for Rituxan is likely to be approved this year. Soon, Herceptin and Avastin will find themselves in a similar situation.
Is Roche Doing Enough? We Think So
Besides expanding into adjuvant therapies, Roche has relentlessly focused on research to prepare itself for the impending biosimilar competition. The company's pipeline remains strong, and it has a large number of breakthrough therapy designations. We estimate that Roche's oncology pipeline had peak sales potential of nearly $6 billion at the beginning of this year. However, the big push might come from neuroscience which is brimming with promising drugs with combined peak sales potential of over $20 billion. One of these drugs, Ocrevus, received FDA approval at the end of March. The drug will be used for treatment of a dult patients with relapsing forms of multiple sclerosis and primary progressive multiple sclerosis. We expect to see a healthy ramp up in the coming quarters. Overall, Roche appears to be doing everything right, and we think that the current market price has already factored in the expected sales loss due to biosimilar competition.
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