The Healthcare Investor: 8/16/18
We are re-starting our weekly as we wrap up 2Q18 earnings and changing the name from Bi-Weekly to The Healthcare Investor. Healthcare stocks underperformed the S&P500 by 20bps in 2Q18 and 40bps in 1Q18 but then materially rallied in July-August. Healthcare stocks are now +9% YTD (year-to-date) vs. +5% S&P500. Bio-Pharma and Life Science Tools stocks drove the sector with many up +10% in the past 6 weeks. Pressures in the Tech industry coupled with continued strong earnings and positive pipeline developments likely drove stock performance. Interesting to note that Facebook’s 20% sell-off on earnings sheds market cap that almost equals the size of Merck (MRK), and more than that of several Pharma and Med Tech bellwethers.
Highlights:
· We recently met with the CFO of AZN and connected with management teams at BIIB, ESRX, ALXN, SHPG/Takeda
· After a strong July, Healthcare stocks are now +9% YTD vs. +5% S&P500.
· BAX: We downgraded BAX to 2/B from 1/B as our thesis has played out for operating margin expansion
· Earnings take-aways below for select stocks
· Merger discounts have narrowed substantially but Takeda-Shire remains +15%
a) Key Areas of Investor Focus in Healthcare:
· Merger Discounts to Implied Take-Out Price: Merger spreads have substantially closed since the AT&T-Time Warner deal was approved. While the gov't is appealing, investors appear to see much higher odds the deals below will close by 4Q18 or early 2019.
o Aetna (AET): +3.9% spread to CVS take-out (+13% on 6/5)
o Express Scripts (ESRX): +8.4% spread to CI take-out(+11.5% on 7/16; +21% on 6/5)...has been very volatile as of late after Carl Icahn was going to challenge the merger and then opted out earlier this week. .
o Shire (SHPG): +15% spread to Takeda take-out (+15% on 7/16;+19% on 6/5)
· CMS announces that it will allow for Medicare Advantage plans to negotiate discounts on Part B drugs. The gov't is basically asking for PBM strategies (like rebates and formularies) in traditional drugs to be applied to Part B drugs that are specialty drugs administered in the doctor's office, outpatient clinic, or certain hospital departments.
b) Rating Updates
· Long-Term Ratings Changes:
o Baxter (BAX): We downgraded BAX to 2/B from 1/B as our thesis has played out for operating margin expansion from the low teens to the low 20's. Baxter was a margin inflection idea and saw the fundamentals improving on both margins and top-line growth. Consensus and investor expectations have now calibrated to our thesis and the stock has moved up accordingly. BAX is +85% over the past 4 years. From here, we see revenue growth of +4-5% and margin expansion to the low 20's% over the next 3-4 years. We believe the stock and investor expectations now adequately reflect this dynamic.
· Healthcare Sentiment Changes: None
Healthcare Sentiment Ratings reflect our views on current prices in the context of our longer-term investment rating.
Blue = Stock is compelling. Recommend buying or increasing position size materially at current prices.
Green = Stock is relatively attractive. Recommend adding to existing position at current prices.
Gray = Stock reflects balanced risk-reward at current prices or no sentiment opinion. No action rec'd.
Yellow = Stock is relatively less attractive. Recommend reducing existing position at current prices.
Red = Stock is not attractive. Recommend exiting existing position at current prices.
c) Best Ideas (at current price points): *High Conviction Risk-Reward
· Healthcare Services & Providers: *ABC, *CVS, *ESRX
· Medical Devices: ABT, *ZBH
· Large Cap Pharma/Biotech: *AGN, *ALXN, *BMY, BIIB, *CELG, *GSK, *PFE, *SHPG
d) Material Updates to Ideas & Industry:
· CMS announces that it will allow for Medicare Advantage plans to negotiate discounts on Part B drugs. To be clear, this means the gov't wants to expand PBM services into other parts of healthcare. This is ironic given the nasty commentary the Trump administration has towards the PBM industry. The gov't is basically asking for PBM strategies (like rebates and formularies) in traditional drugs to be applied to Part B drugs that are specialty drugs administered in the doctor's office, outpatient clinic, or hospital. The Trump Blueprint continues to be an overhang for bio-pharma and healthcare supply chain stocks. We are at high conviction prices for CVS-AET and CI-ESRX.
· Underwriting Cycle shifting in Managed Care? Given a pick-up in healthcare utilization trends and lower favorable reserve development at some health insurers, some lingering, but inconclusive, debates are emerging post earnings following UNH and HCA and others.
· AstraZeneca (AZN): We recently met with the CFO of AZN. He highlighted the move away from Primary Care and toward Specialty medicine, like Oncology. This will likely result in a 50-50 split over the long-term between Specialty and Primary Care. He stressed that the last few years were about investment in new products given patent expirations. Now, he sees products launching and ramping, which are dragging margins. As revenue ramps, they think operating margins can grow to the 30-40% range (current 26%). China is an important market for growth as the middle class expands and demands better healthcare. He noted that while specialty pricing may differ in emerging markets, the dollar operating margin is very similar. While the Oncology program progresses, they seem confident in the long-term revenue prospects and will look for data to further validate the growth potential for investors.
· Shire (SHPG): +15% spread to take-out): Takeda CFO participated in a conference call about Shire acquisition with investors. He sees the acquisition between Takeda and Shire as looking more likely. Takeda announced it had obtained unconditional clearance for the Shire acquisition from the US Federal Trade Commission (FTC). Takeda still intends to propose the Shire acquisition as a special proposal at an extraordinary shareholders meeting after obtaining approval from 20 countries. However, the process should go faster if approval is gained sooner than expected. Acquisition has to be approved by a two thirds majority of Takeda shareholders with at least 50% exercising their voting rights. Takeda should gain approval from key institutional investors, which will secure approval the Shire acquisition.
Earnings Take-Aways:
· AmerisourceBergan (ABC): Good F3Q18 from better Pharma segment results and a lower than expected tax rate. Guidance was maintained despite pressures from the PharMEDium segment due to FDA compliance issues and the Lash segment due to higher costs from duplicative systems during a product launch. While these will take the rest of the FY18 to remediate, the other parts of our thesis remain in place. Over the next 1-2 years, we see a rebound back to historical margin levels as ABC leverages investments in distribution centers for the recently acquired Walgreens-Rite Aid stores. We see this driving a re-valuation from trough to normalized levels.
· Cigna (CI) /Express Scripts (ESRX): Solid results out from both ESRX (guidance raise on 2Q beat and better 2019 initial outlook) and CI (EPS beat, 2018 guidance raise) though attention is on the shareholder vote scheduled for 8/24 following Carl Icahn's initial position against the deal that was recently dropped. CI stressed their commitment to the deal and see resistance from those not really familiar with healthcare. We agree and see CI-ESRX following the UNH model. CI/ESRX have been very volatile as of late but has recently started to settle down.
· Alexian (ALXN): Strong 2Q18 as fundamental metrics continue in the right direction. However, stock as pulled back -20% as 1. Baker Bros are selling 8.5M shares. 2. REGN 3918 will start phase 2 trial early next year in a subcu (ALXN1210 is IV & subcu). While competing products are in clinical trials, the bar remains high from ALXN's Soliris/1210 franchise but 20-30% of patients are non-responders. We see competition targeting these people more than displacing ALXN.
· Bristol-Myers (BMY): Strong 2Q18 driven by better results in key franchises Opdivo, Yervoy, & Eliquis. However, stock sold off 5% after the EU did not approve Opdivo-Yervoy in kidney cancer. This was surprising after strong data and US approval. However, EU is stating they would like to see Opdivo alone vs. Opdivo-Yervoy before approving. This data exists in Phase 2, which showed a 20% ORR (overall response rate) in Opdivo vs. 40% ORR in combo therapy. BMY is appealing but it is unclear why the EU regulatory body is taking this stance.
e) Recent Pipeline Readouts & Updates:
· BIIB: Head of Alzheimer’s at BIIB met with investors. He sounded confident on the recent BAN2401 data ahead of the subgroup analysis, a key catalyst potentially in October. He also confirmed that BIIB / Eisai have initiated discussions with global regulators. We are doubtful the Phase 2 BAN2401 data is enough for approval but nothing has come close to this data in Alzheimer's. At a recent medical conference, BIIB's partner Eisai on BAN2401 (for Alzheimer's with recent positive Phase 2 data) defended the APOE4 patient imbalance. APOE4 leads to a higher risk of Alzheimer's Disease but has less impact on the progress of the disease. Eisai argues that there was an imbalance caused by the restriction on the allocation of ApoE4 carriers in the study but was corrected by the MMRM (Mixed Models for Repeated Measures) analysis. The restriction may have showed better than expected results. Eisai has stated that the ApoE4 carrier allocation will not be applied in the Phase 3 trial, which could limit the read through of the Phase 2 trial. As part of our thesis, we viewed BIIB as having the best Alzheimer's pipeline, which carries a high risk, high reward profile. We are highly encouraged by BIIB's results and believe it strengthens the odds that BIIB's aducanumab may work which could read out in the next 12-18 months.
· GSK: GSK recently announced their new doublet in HIV met the Phase 3 endpoint. This means growth in the HIV/ViiV segment should continue in the +9-10% range with potential for more given the disruptive nature of the doublet relative to current triple therapies. The doublet provides equal benefits but lower long-term side effects.
f). Upcoming Events/Catalysts:
· Anytime: Trump Administration Healthcare "Blueprint"
· 8/16: BMY's US FDA approval for Opdivo in 3L SCLC (small cell lung cancer)
· 8/24: CI-ESRX Shareholder vote to approve merger
· 9/14: AGN Aesthetics Analyst Day
· 9/23: MRK PDUFA U.S. approval for Keytruda + chemo in 1L non-squamous NSCLC (KN-189)
· 3Q18/4Q18: CVS-AET merger expected to close
g) Key Device & Bio-Pharm Trial Events:
· Alexion (ALXN): 2H18: Expects Soliris phase III neuromyelitis optica (NMO) data in 2018
· Abbvie (ABBV): 2H18: Full P3 data of Orilissa in uterine fibroids; EU approvals and launches of Humira (ABBV) biosimilar
· Amgen (AMGN): Potential biosimilar launches on Neulasta (AMGN product)
· AstraZeneca (AZN): 2H18: Cardiovascular outcome trial for SGLT2 Forxiga DECLARE study; 2H18: Imfinzi/Treme in 1L lung cancer (NEPTUNE)
· Bristol-Myers Squibb(BMY): Aug '18: U.S. approval for 3L+ in SCLC (PDUFA 8 /16/18); 2H18: CM-331 P3 Opdivo data in 2L SCLC; Phase 3 data in the following cancers: HCC, GBM, MM, NSCLC
· Celgene (CELG): 2H18: JCAR017 (CAR-T cancer therapy) additional pivotal data updates
· Lilly (LLY): 2H18: Trulicity REWIND study (for Cardiovascular benefit); 2H18: NVO P3 oral Semaglutide data; P3 Cyramza data (RELAY) for 1L lung cancer
· Merck (MRK): 10/30: MRK PDUFA U.S. approval for Keytruda+ chemo in 1L metastatic squamous cell lung carcinoma;2H18: Lynparza P3 data in pancreatic cancer
· Pfizer (PFE): 8/28: Tafamadis data expected at a medical conference. Important pipeline asset for PFE that could be a $1B opportunity; 2H18: tanezumab P3 Pain data
· Roche: 2H18: P3 data in RCC IO/Avastin combo for all comers and PDL1>50%; P3 data in Colorectal from COTEZO trial; P3 data in Melanoma from TRILOGY trial; Tecentriq + chemo +/- steroids data in NSCLC (5 studies), RCC, SCLC, and TNBC (in 2018)
· Shire (SHPG): 2H18: SHP643 (HAE) US approval expected; SHP621 P3 data expected for Eosinophilic Esophagitis (EoE), potential $1B market oppty; 12/21: PDUFA on SHP 555 Prucalopride for Chronic Idiopathic Constipation (CIC)
h) Ratings & Summary: (Price Targets Subject to change during earnings)
i) Interesting Charts: