February 6, 2015 Roche Holding AG Current Recommendation Prior Recommendation Neutral Date of Last Change 02/06/2015 Current Price (02/05/15) $33.81 Target Price $31.00 UNDERPERFORM SUMMARY (RHHBY-OTC) Roche core earnings came in at $1.95 per American Depositary Receipt (ADR) in 2014 but missed the Zacks Consensus Estimate of $1.99 per ADR. Revenues of $51.9 billion however beat the Zacks Consensus Estimate of $50.4 billion. The company is well-placed in the breast cancer market with drugs like Herceptin, Perjeta and Kadcyla, and continues to strengthen its already dominant position. However, generic competition for Xeloda, Zelboraf and Pegasys will continue to hamper sales. Lucentis is expected to face strong competition in the DME and wet age-related macular degeneration space. We expect generics to adversely impact top-line growth in 2015 and hence downgrade our recommendation to Underperform. SUMMARY DATA 52-Week High $38.50 52-Week Low $33.48 One-Year Return (%) -0.41 Beta 0.59 Average Daily Volume (sh) 2,118,451 Shares Outstanding (mil) 6,795 Market Capitalization ($mil) $229,744 Short Interest Ratio (days) N/A Institutional Ownership (%) 1 Insider Ownership (%) N/A Risk Level * Low, Type of Stock Large-Growth Industry Large Cap Pharma Zacks Industry Rank * 201 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) Annual Cash Dividend $0.70 Dividend Yield (%) 2.07 5-Yr. Historical Growth Rates Sales (%) N/A Earnings Per Share (%) N/A Dividend (%) 7.4 P/E using TTM EPS N/A P/E using 2015 Estimate 17.5 P/E using 2016 Estimate 16.0 Zacks Rank *: Short Term 1 3 months outlook 4 - Sell * Definition / Disclosure on last page 2013 52,214 A 2014 52,583 A 2015 51,674 E 2016 53,710 E Earnings per ADR Estimates (EPADR is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $1.99 A 2014 $1.95 A 2015 $1.93 E 2016 $2.11 E Projected EPADR Growth - Next 5 Years % 6 Note: The ratio of ADR per share was changed on Mar 4, 2014. Hence, 2012 and 2013 numbers have been restated retrospectively. 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 111 North Canal Street, Chicago IL 60606
OVERVIEW Founded in 1896, Switzerland-based Roche Holding Ltd. (RHHBY) is a leading health care company engaged in discovering, developing and providing innovative diagnostic and therapeutic products and services for diverse medical needs. These products and services enable early detection and prevention of diseases along with treatment and monitoring. The company conducts its operations through two segments Pharmaceuticals and Diagnostics. Pharmaceuticals: Key focus areas in this segment include Oncology, Virology, Inflammation, Metabolism and Neuroscience. Pharmaceutical Portfolio Oncology Virology Inflammation Metabolism Important Drugs/Candidates Herceptin, Avastin, MabThera/Rituxan, Xeloda and Tarceva Pegasys, Tamiflu Actemra/RoActemra, MabThera/Rituxan Accu-check blood glucose meters Diagnostics: The Diagnostics Division operates in five segments Roche Professional Diagnostics, Roche Diabetes Care, Roche Molecular Diagnostics, Roche Applied Science and Roche Tissue Diagnostics. Roche generated revenues of CHF47.5 billion in 2014. Sales from the Pharmaceuticals division came in at CHF36.7 billion, while the Diagnostics division contributed CHF10.8 billion. Key Drugs Indication Blood cancers, specifically non-hodgkin s lymphoma (NHL), chronic lymphocytic leukemia (CLL), MabThera/ and for rheumatoid arthritis 6,900 Rituxan (RA) Advanced colorectal, breast, lung, kidney and ovarian Avastin cancer 6,417 Herceptin HER+ breast cancer 6,275 Eye conditions specifically wet age-related macular degeneration, macular edema following retinal vein occlusion (RVO) and diabetic macular edema (DME). 1,701 Lucentis Tarceva Lung cancer 1,291 Actemra RA 1,224 Pegasys Hepatitis B and C 1,015 Sales in 2014 (in millions of CHF) Equity Research RHHBY Page 2
REASONS TO SELL RISKS Pipeline Setbacks: Roche suffered quite a few setbacks in 2014. Phase III studies on bitopertin for schizophrenia failed to meet primary endpoints. Another phase III study on gantenerumab in earlystage Alzheimer s disease was discontinued after a pre-planned futility analysis. Moreover, Roche announced in Mar 2014 that an independent data monitoring committee has recommended stopping its phase III study, METLung, on oncology candidate onartuzumab (MetMab) due to the lack of clinically meaningful efficacy. Earlier in Jul 2013, Roche had announced the termination of its phase III trial, AleCardio, on pipeline candidate aleglitazar. The decision to terminate the trial was taken after the independent Data and Safety Monitoring Board (DSMB) recommended the company to halt the trial due to safety signals and lack of efficacy following the results of a regular safety review. The trial was being conducted to evaluate the efficacy and safety of aleglitazar in patients with a recent acute coronary syndrome event and type II diabetes. Consequently, Roche terminated the AleCardio trial along with other trials related to aleglitazar. Competition from BioSimilars: Stiff competition from biosimilars looms large on some of Roche s key drugs such as Avastin, Rituxan and Herceptin in the long term. The entry of biosimilars for these key drugs will adversely impact their sales. Competition from Generics and Other Drugs: Sales of Pegasys (approved for hepatitis B and C), continue to decline due to the competition from a new generation of hepatitis C treatments. Meanwhile, Xeloda lost patent protection in Europe in 2013 and in the U.S. in 2014, opening up the entry of generics. Valcyte is also expected to face stiff competition from generics in 2015. Lucentis is expected to face strong competition in the diabetic macular edema (DME) and wet age-related macular degeneration space. Regeneron Pharmaceuticals, Inc. s eye drug Eylea received FDA approval for a third indication the treatment of DME, thereby posing competition for Lucentis. Leader in Breast Cancer Drugs: Roche has a strong presence in the oncology market. In particular, the company dominates the breast cancer market on its HER2 franchise with strong demand for drugs like Herceptin. The HER2 franchise includes Herceptin, Perjeta and Kadcyla. Sales of the HER2 franchise grew 20% in 2014. This might translate into strong top-line growth and we will reconsider our recommendation in such a scenario. Development of portfolio beyond oncology: Roche is making efforts to develop its portfolio beyond oncology. Actemra has proven to be a strong growth driver for Roche. The subcutaneous formulation of Actemra/RoActemra for RA was recently approved in the EU, which should further boost sales. On the other hand, ophthalmology drug Lucentis also shows promise. The ophthalmology franchise also has an interesting candidate in its pipeline lampalizumab. Roche initiated two phase III studies on lampalizumab, which is being evaluated for the treatment of geographic atrophy (GA). Moreover, in a bid to expand its respiratory product portfolio, Roche acquired InterMune, Inc.,for $8.3 billion in Sep 2014, thereby adding Esbriet to its portfolio. Esbriet was approved in 2011 in Europe for the treatment of adults with mild-to-moderate idiopathic pulmonary fibrosis. The drug was recently approved by the FDA for the same. These efforts might bear fruit in 2015 and we will reconsider our recommendation in such a scenario. Equity Research RHHBY Page 3
RECENT NEWS Roche Reports Positive Data on Leukemia Drug Gazyva Feb 4, 2015 Roche announced positive results from a phase III study, GADOLIN, on leukemia drug Gazyva. The study evaluated treatment options for patients suffering from indolent non-hodgkin s lymphoma (inhl) who are refractory to Rituxan. The study showed patients surviving significantly longer without their disease worsening or death when treated with Gazyva plus Treanda followed by only Gazyva when compared to only Treanda. An independent data monitoring committee determined that the study met its primary endpoint of progression-free survival during a pre-planned interim analysis. Consequently, the study was stopped before its protocol-specified final analysis. Gazyva generated sales of CHF49 million in 2014. We remind investors that Gazyva was approved by the FDA for use in combination with chlorambucil in people with previously untreated chronic lymphocytic leukemia in 2013 under Breakthrough Therapy designation. The drug was approved for the same indication by the European Commission in Jul 2014 under the brand name Gazyvaro. Initial uptake of the drug was positive in Europe, while competition and limited use of chlorambucil negatively impacted its uptake in the U.S. In Dec 2014, the FDA approved a supplemental biologics license application expanding Gazyva's label to include data that showed significant improvements of Gazyva plus chlorambucil over MabThera/Rituxan plus chlorambucil. Roche s efforts to expand Gazyva s label for inhl will boost its sales further. Roche's Anti-PDL1 Gets Breakthrough Status for Lung Cancer Feb 2, 2015 Genentech announced that the FDA has granted Breakthrough Therapy designation to its investigational immunotherapy MPDL3280A (anti-pdl1) for the treatment of PD-L1 positive non-small cell lung cancer (NSCLC) in patients whose disease progressed during or after platinum-based chemotherapy (in addition to an appropriate targeted therapy for those with an EGFR mutation-positive or ALK-positive tumor). We note that this is the second Breakthrough status obtained by MPDL3280A. In May 2014, the candidate was designated as Breakthrough Therapy for the treatment of metastatic bladder cancer. Breakthrough Therapy designation is granted to candidates that are being developed for the treatment of serious diseases to expedite the process of development and review so as to ensure quick access to these therapies by patients following their approval. According to the American Cancer Society, over 221,000 Americans are expected to be diagnosed with lung cancer in 2015. Moreover, NSCLC accounts for 85% of all types of lung cancer. Roche is developing MPDL3280A as a treatment of the PD-L1 expression in cancer. The company said that while all studies are evaluating MPDL3280A for the PD-L1 expression, some are specifically studying the candidate for tumors characterized as PD-L1 positive. Roche intends to initiate additional phase III studies on MPDL3280A for other types of tumor in 2015. Roche Misses on Earnings in 2014, Beats on Revenues Jan 28, 2015 Equity Research RHHBY Page 4
Roche s core earnings came in at $1.95 per American Depositary Receipt (ADR) in 2014 but missed the Zacks Consensus Estimate of $1.99 per ADR. Revenues of $51.9 billion beat the Zacks Consensus Estimate of $50.4 billion. All growth rates mentioned below are on a year-over-year basis and at constant exchange rates. 2014 Results in Detail Roche reports business in two divisions: Pharmaceuticals and Diagnostics. Sales from the Pharmaceuticals division increased 4% to CHF36.7 billion driven by solid growth across the oncology portfolio (HER2+ breast cancer medicines and Avastin) and the immunology franchise (Actemra and Xolair). Sales from HER2 breast cancer franchise (+20%) were driven by strong demand for new drugs Perjeta and Kadcyla along with the legacy drug Herceptin. Sales of Avastin were up 6% due to increased demand in the ovarian and colorectal cancer indications. Strong sales of blood cancer drug Rituxan/MabThera (+2%) in Europe were driven by increased market share in both follicular lymphoma and a first-line treatment for chronic lymphocytic leukemia. Sales of rheumatoid arthritis drug Actemra (+23%) were strong in all major markets driven by increased use in monotherapy and earlier use in treatment for rheumatoid arthritis, with significant uptake of the new subcutaneous formulation. Ophthalmology drug, Lucentis (+2%) was up on its increased adoption for the treatment of diabetic macular edema (DME). Asthma drug Xolair (+25%) showed strength as its demand increased after the FDA approved it for another indication chronic idiopathic urticaria. We note that Novartis licensed Xolair from Roche. Roche markets Xolair in the U.S. However, sales of chemotherapy drug Xeloda plunged 46% due to generic competition in the U.S. and Europe. Pegasys was down 20% due to competition from a new generation of hepatitis C treatment. Tamiflu (+54%) grew robustly toward the end of the year as a result of the flu epidemic in the U.S. Meanwhile, the acquisition of InterMune in Sep 2014 added Esbriet to Roche s portfolio. Esbriet was recently approved by the FDA for the treatment of idiopathic pulmonary fibrosis. The company expects to launch the drug in the U.S. in 2015. Revenues from the Diagnostics division went up 6% to CHF 10.8 billion driven by solid performance of the professional diagnostics (+8%) unit, which was in turn propelled by the immunodiagnostics business (+13%). Tissue diagnostics (+10%) also performed impressively. Diabetes care sales were up 1% while molecular diagnostics sales increased 6%. Roche launched 14 key products in 2014, including the new cobas 6800 and cobas 8800 systems for molecular testing, and cobas 6500. 2015 Outlook Roche expects sales in 2015 to increase in low-to-mid single digits. The company expects its core earnings to grow at a higher rate than sales. Pipeline Update Equity Research RHHBY Page 5
Roche s pipeline progress in 2014 was encouraging. Avastin was approved for cervical cancer in the U.S. and platinum-resistant ovarian cancer in Europe. Positive news flowed in when Gazyvaro (trade name Gazyva outside the EU) was approved for chronic lymphocytic leukemia in Europe. Roche also reported positive overall survival data from the phase III study, CLEOPATRA, on Perjeta in HER2-positive metastatic breast cancer wherein it was observed that adding Perjeta to Herceptin and chemotherapy increased the survival time for treatment-naïve patients by five years. We note that cancer immunotherapy is a key focus area for Roche with currently seven candidates under development. The FDA granted Breakthrough Therapy designation to cancer immunotherapy candidate anti-pdl1 (MPDL3280A) for bladder cancer and Lucentis for diabetic retinopathy. Meanwhile, Roche initiated phase III trials on ophthalmology candidate lampalizumab for the potential treatment of geographic atrophy. However, there were a few setbacks as well as phase III studies on bitopertin for schizophrenia failed to meet primary endpoints. Also, a phase III study on gantenerumab in early-stage Alzheimer s disease was discontinued after a pre-planned futility analysis. Roche also discontinued the development of onartuzumab in advanced MET-positive non-small cell lung cancer when it failed to show clinically meaningful efficacy. Roche Discontinues Gantenerumab Development Dec 19, 2014 Roche announced that it will discontinue SCarlet RoAD (WN25203), a phase III study on pipeline candidate gantenerumab, which was being developed for Alzheimer s disease. The decision to discontinue was based on the results of a pre-planned futility analysis and recommendation by the independent Data Monitoring Committee. Roche Announces Results from Study on Breast Cancer Dec 19, 2014 Roche announced results from a phase III study, MARIANNE, in patients with previously untreated advanced HER2-positive breast cancer. The study was designed to evaluate three HER2-targeted regimens in previously untreated (first-line) advanced HER2-positive breast cancer (Kadcyla alone, Kadcyla plus Perjeta, Herceptin plus chemotherapy). Data from the study showed that the three regimens helped people live without their disease worsening for a similar amount of time, thereby meeting its noninferiority endpoint as assessed by an Independent Review Committee. However, the Kadcyla-containing treatment arm failed to improve progression-free survival when compared to Herceptin and chemotherapy. Roche's Avastin Label Expansion Approved by FDA Nov 17, 2014 Roche announced that the FDA has approved Avastin in combination with chemotherapy for the treatment of women with platinum-resistant, recurrent ovarian cancer. The approval was based on encouraging results from the phase III study, AURELIA. The study was conducted among women suffering from recurrent, platinum-resistant ovarian cancer who were either on chemotherapy alone or Avastin added to chemotherapy. Results from the study showed that the addition of Avastin to chemotherapy reduced the risk of the disease worsening or death by 62% (also known as progression-free survival) as compared to women who received only chemotherapy. Equity Research RHHBY Page 6
We note that Avastin has already received approval in the EU earlier in 2014 for treating women suffering from platinum-resistant, recurrent ovarian cancer. We remind investors that Avastin is approved in Europe for the treatment of advanced stages of breast cancer, colorectal cancer, non-small cell lung cancer, kidney cancer and ovarian cancer. In the U.S., Avastin is approved for the treatment of colorectal cancer, non-small cell lung cancer, kidney cancer, cervical cancer and ovarian cancer. Moreover, the drug is approved in the U.S. for progressive glioblastoma following prior therapy. We note that Avastin is one of the leading drugs in Roche s portfolio. Avastin generated sales of CHF4.7 billion in the first nine months of 2014. We are encouraged by Roche's efforts to expand the drug s label, which should further boost sales. CHMP Recommends Label Update for Esbriet in Idiopathic Pulmonary Fibrosis Oct 24, 2014 Roche announced that Esbriet received a positive opinion from the Committee for Medicinal Products for Human Use (CHMP). The update strengthens the efficacy claims and supports the well-established safety profile based on the additional data from the phase III trial, ASCEND. Esbriet was approved in 2011 in Europe for the treatment of adults with mild to moderate idiopathic pulmonary fibrosis. As a result of the positive CHMP opinion, the prescribing information in the EU will now be updated to include data from the ASCEND trial. Earlier in the month, the FDA approved Esbriet in the U.S. under the Breakthrough Therapy Designation. The approval of Esbriet in the U.S. was based on data from the ASCEND trial and supported by two other large phase III trials CAPACITY 1 and 2. The data from the ASCEND study showed that more patients who received Esbriet had a delay in the decline of lung function compared to those who received placebo as defined by the primary endpoint of percent change in Forced Vital Capacity (FVC). FVC is a measure of how well the lungs work based on the amount of air one can exhale with force after inhaling as deeply as possible. Esbriet was added to Roche s portfolio through the acquisition of InterMune in Sep 2014. Roche to Acquire InterMune Sep 29, 2014 In a bid to expand its respiratory product portfolio, Roche announced that it has entered into a definitive merger agreement to acquire California-based biotechnology company InterMune, Inc. for $74.00 per share or $8.3 billion. The offer price of $74.00 per share represents a premium of 38% to InterMune s closing price on Aug 22, 2014. The agreement has been approved by boards of both the companies. Roche will commence a tender offer by Aug 29 to acquire all outstanding shares of InterMune. Roche expects the transaction to be neutral to the bottom line on a core basis by 2015 and accretive from 2016 onward. InterMune focuses on the research, development and commercialization of innovative therapies in pulmonology and fibrotic diseases. InterMune s lead drug Esbriet is approved for idiopathic pulmonary fibrosis (IPF) in the EU (2011) and Canada (2012). The drug is under review in the U.S. Equity Research RHHBY Page 7
The acquisition will further expand Roche s respiratory product portfolio, which markets Pulmozyme and Xolair in the U.S. The FDA had recommended InterMune to conduct an additional phase III trial to support the efficacy of Esbriet. In May 2014, InterMune resubmitted its New Drug Application (NDA) for Esbriet based on encouraging top-line results from the phase III ASCEND study, which was announced in Feb 2014. In Jul 2014, Esbriet was granted breakthrough therapy designation in the U.S. A final decision from the FDA on the approval of Esbriet is expected by Nov 23, 2014. VALUATION Roche core earnings came in at $1.95 per American Depositary Receipt (ADR) in 2014 but missed the Zacks Consensus Estimate of $1.99 per ADR. Revenues of $51.9 billion beat the Zacks Consensus Estimate of $50.4 billion. The company is well-placed in the breast cancer market with drugs like Herceptin, Perjeta and Kadcyla, and continues to strengthen its already dominant position. Roche is simultaneously developing drugs for other indications. Its oncology portfolio looks solid as ever and we expect further traction. We are also impressed by the company's efforts to grow its portfolio beyond oncology to immunology and ophthalmology. We are encouraged by Roche s performance so far in 2014. However, generic competition for Xeloda and competition from other HCV treatments for Pegasys will negatively impact sales in 2015. Lucentis is also expected to face competition. Roche is currently trading at a 2015 P/E multiple of 17.5 compared to the industry average of 19.6 and the S&P 500 average of 16.4. Hence, we are downgrading our recommendation to Underperform. Our target price of $31.00 is based on 16.1x of our 2015 EPADS estimate. Key Indicators P/E P/E Est. 5-Yr P/CF F1 F2 EPADR Gr% (TTM) Roche Holdings AG (RHHBY) 17.5 16.0 6.1 16.7 P/E (TTM) P/E 5-Yr High (TTM) P/E 5-Yr Low (TTM) Industry Average 19.6 17.4 8.0 16.3 20.8 29.2 10.0 S&P 500 16.4 15.4 10.7 15.0 18.9 19.4 12.0 Johnson & Johnson (JNJ) 16.5 15.8 5.5 14.5 17.2 18.2 12.1 Novartis AG (NVS) 18.4 17.3 7.4 18.6 19.0 18.9 9.8 TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow Roche Holdings AG (RHHBY) P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE (TTM) D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA (TTM) 11.4 18.0 1.2 0.8 1.9 14.1 Industry Average 7.0 7.0 7.0 33.2 0.6 2.6 15.4 S&P 500 7.2 9.8 3.2 24.7 2.0 Equity Research RHHBY Page 8
Earnings Surprise and Estimate Revision History DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of RHHBY. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will underperform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1133 companies covered: Outperform - 16.5%, Neutral - 76.9%, Underperform 6.4%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research RHHBY Page 9
Analyst Last updated by Copy Editor Lead Analyst QCA Reason for Update Ekta Bagri Ekta Bagri Sayanti Sinharoy Ekta Bagri Arpita Dutt 4Q14 Earnings and Rec change Equity Research RHHBY Page 10