a) Key Areas of Investor Focus in Healthcare
· Investors are digesting newsflow after 4Q17 earnings results.
· Year to Date (YTD):Bio-Pharma continues to underperform the overall markets with Medial Devices and Healthcare Services outperforming. We see this as a compelling setup for Bio-Pharma names with strong pipelines or material disconnects with intrinsic value.
· Tax Reform: Most companies raised 2018 guidance based on lower tax benefits from tax reform.
· M&A:Rumors surfaced that Walgreens (WBA) was in talks to acquire AmerisourceBergen (ABC) but no deal was reached and talks have fallen apart.
· The flu season was worse than average this year. Hospital stocks that have lagged for 2 years on low utilization are rallying. Managed Care stocks have been volatile as people struggle with either a temporary spike in medical costs or something more sustained after +2 years of low utilization. We see something more sustained that was part of our HCA upgrade. We are now +2 years post the Affordable Care Act expansion. Massachusetts took about 2 years after a large expansion for admissions and ER visits to rebound from weak levels and return to normalized growth again.
· Healthcare Politics: We sense the policy debate in healthcare is shifting from tax reform tailwinds to drug pricing rhetoric from the White House. Recent newsflow has increased the focus on the mid-term elections outcome.
· Amazon (AMZN) risk re-emerged as the company announced a JV with JP Morgan and Berkshire Hathaway to address soaring healthcare costs. It sounds like they will focus on better technology platforms.
b) Rating Updates
· Ratings Changes:
- TEVA: On 2/16, we downgraded the risk rating to C (2/C) from B (2/B)
- AZN: On 2/13, we downgraded our risk rating to C (2/C) from A (2/A)
- AET: On 2/12, we upgraded AET to 1/B from 2/B
- CVS: On 2/9, we transitioned coverage of CVS to healthcare with a 1/B rating
- GSK: On 1/26, we upgraded GSK to 1/A from 2/A
· Healthcare Sentiment Changes (see Sentiment definitions below):
- Raised CVS to Blue after transition of coverage
- Raising BIIB to Green after recent sell-off after BIIB expanded the size of its Alzheimer's trial to improve the power. We still see Alzheimer's and a developing pipeline as compelling optionality.
- Raising MCK to Blue from Green on stabilizing industry fundamentals and attractive risk-reward.
c) Best Ideas (at current price points): *High Conviction
- Healthcare Services & Providers: *ABC,*AET,*CVS,*ESRX,*MCK,
- Medical Devices: ABT,*ZBH
- Large Cap Pharma/Biotech: *AGN,*ALXN,*BMY,*BIIB,*CELG,*GSK,*PFE,*SHPG
d) Material Updates to Ideas:
· Drug Distributors:From a company fundamentals standpoint, all 3 drug distributors (ABC,MCK,CAH) reported stronger than expected results and stabilizing industry trends. The last 1-2 years drove stock volatility as the industry reported mixed trends to stability could be key to improving valuations.
· Shire(SHPG):Reported a strong 4Q with pipelines advancing but the stock continues to underperform. We think the stock is on the cusp of rebounding as Roche is now launching competing hemophilia products, a key overhang for SHPG. As investors see the ramp of Roche's product Hemlibra, it will permit investors to better forecast SHPG's hemophilia segment. Recall, Sanofi acquired Bioverativ (BIVV, a hemophilia competitor to SHPG) for $105/sh in cash or $11.6B. On a similar valuation to BIVV, SHPG would trade at $408 vs today at $120-130. We view SHPG as a take-out given this dislocation to fundamentals.
· AstraZenaca(AZN):We downgraded our rating to 2/C (C=high risk) from 2/A (A=Low Risk). We see the C rating as more relevant given AZN has less balance sheet flexibility relative to peers due to a high dividend. More specifically AZN generates $2-4B in free cash flow but pays about $3.5B in dividends. AZN borrows to offset the cash flow limitations as total debt exceeded $17.8B in 2017, up from $15B in 2015 but earnings are only up marginally. In sum, AZN is borrowing to fund the cash needs of the franchise but this is effectively pulling forward from future growth creating an above average risk profile.
· GlaxoSmithKline(GSK):We recently upgraded GSK to 1/A. We see GSK's stock weakness in 2017 as driven by dividend cut concerns from a potential acquisition coupled with mixed messaging from a new management team and margin headwinds from a large product (Advair) going generic. In 2018, we see margins and revenue growth hitting trough levels and then accelerating in 2019-21 driven by the confluence of Advair generics and the timing of a pretty good pipeline providing optionality to accelerate revenues above current expectations for +2-3% in 2019-20. At current prices, we see +40-50% upside over the next 3-4 years with support from a 5% dividend yield.
· CVS/Aetna(AET): We upgraded AET as we transitioned CVS(1/B) to healthcare coverage. We view AET's 14-15% take-out spread for cash and CVS stock as a compelling way to own CVS at an attractive discount. At current prices, we view CVS as a high conviction investment idea. We expect the AET merger to gain regulatory approval in 2H18 given very little business overlap and lower costs for consumers. This moves both AET and CVS towards a more vertically integrated healthcare model and allows them to close the gap to United Health's model. AET-CVS should generate more than $240 billion in 2019 revenue and potentially $10.5-11.5B in free cash flow, a 13-14% FC yield.
e) Pipeline Readouts & Updates:
· Allergan (AGN):Announced positive phase III topline results in the ACHIEVE I trial for the drug Ubrogepant in the treatment of acute migraine. ACHIEVE I results signal no safety issues for the product but we will learn full details at a medical conference presentation later in 2018. ACHIEVE II is expected to readout in the next 3-4 months. Migraine is a large un-met need as 1/3 of the market does not respond to therapy.
· Bristol-Myers Squibb(BMY):Announced the Phase III CM-227 study of Opdivo combined with Yervoy demonstrated improved progression free survival (PFS) vs chemo in first line (1L) non-small cell lung cancer (NSCLC) in patients with high tumor mutation burden (TMB) regardless of the PDL1 biomarker expression. BMY noted that the study continues to evaluate overall survival (OS) which is expected in 2H18 or early 2019.
· Pfizer(PFE):FAILED:Bavencio/Avelumab (I-O): Phase III data in 2L NSCLC (JAVELIN Lung 200), Missed Overall Survival (OS) end point. Could mean PFE's immuno-oncology agent is less efficacious as peers, which is tricky as the drug moves to more important combo therapy trials.
· Biogen(BIIB):Expands P3 Alzheimer's trial to better power end point. Stock falls 10-15% as investors think it could mean the trial is not going well. Also means an interim readout likely will not happen in 2018. FAILED: P2b study in ischemic stroke (ACTION 2)
f). Upcoming Events/Catalysts:
- 3/1-2: DB Nashville Trip to visit hospital companies
- 3/5: UNH markets with Wells in Chicago (we are meeting with senior mgt)
- 3/6-8: Citi Cleveland Clinic Event
- 3/10-12: ACC (American College of Cardiology) Medical meeting in Chicago
- 3/12-14: Cowen Healthcare Conf in Boston (we are attending)
- 3/13-15: Barclays HC Conf
- 3/23: BDX hosts Wells and investors
f) Key Device & Bio-Pharma Product Events:
· Allergan(AGN):1H18: 2nd Ubrogepant for Migraine Ph3 trial results (ACHIEVE II); Esmya FDA approval expected in mid-18 after positive data. AGN does not expect an Adcom and is filing for a broad label; Atogepant Ph2B results for chronic migraine
· Alexian(ALXN): 2Q18: Expects phase III ALXN1210 PNH data (naïve and switch) and Soliris phase III NMO data in 2Q18. We expect the data to materially impact ALXN as they are critical to assessing ALXN's potential beyond Soliris in PNH, aHUS and gMG.
· BMY: 1H18: CM-227 trial P3 detailed data in 1L NSCLC; 1H18: CM-331 trial Opdivo data in 2L SCLC; 2H18: CM-459 trial Opdivo data in 1L HCC
· BIIB: 1H18: BIIB098: next gen Tecfidera, P3 data in Multiple Sclerosis
· Celgene(CELG): 1H18: Revlimid in Follicular lymphoma Ph3 RR iNHL and DLBCL (AUGMENT & ROBUST trials); Mid-18: P3 data from Luspatercept in MDS and beta-thalassemia (BELIEVE & MEDALIST trials)
· Eli Lilly(LLY):2018: NOVO will launch their oral GLP-1 (Semaglutide); Will compete with LLY's Trulicity
· Novartis(NVS): Mid-2018: Kymriah approval and launch in DLBCL (break-through designation); Mid-2018: Aimovig/AMG334 approval and launch. First to file in new migraine drug class; Mid-2018: Launch of ACZ885/CANTOS Ph3 data at medical meeting; Mid-18: Kisqali data from MONALEESA-3 trial in Advanced breast cancer
· Merck(MRK): 1H18: Phase 3 PFS data from ECHO-301 in 1L Melanoma in combination with INCY's epacadostat.
· SHPG:2H18: SHP643 (HAE) US approval expected; 2H18: Xiidra (Dry Eye) EU approval expected
· PFE: 2018: Phase III data in 2L platinum resistant ovarian cancer (JAVELIN Ovarian 200) 1L renal cell carcinoma (2018).
· Roche: Now-2018: Full HAVEN3 (ACE910 in non-inhibitors) P3 data at medical conference in future
g) Ratings & Summary:
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