GuruFocus Premium Membership

Serving Intelligent Investors since 2004. Only 96 cents a day.

Free Trial

Free 7-day Trial
All Articles and Columns »

Roche Holdings: A Core Long-Term Holding

October 15, 2011 | About:
Chandan Dubey

Chandan Dubey

97 followers
Roche: Selected financials

1704336288.jpg

Company history

Roche was founded in 1896 in Basel, Switzerland and has grown from a small drug laboratory to a healthcare company active in more than 130 countries. Roche is involved in discovery, development and manufacturing of pharmaceuticals and diagnostic symptoms, and is a producer of vitamins and carotenoids.

The company's Pharmaceutical division engages in the research and development, manufacture and distribution of pharmaceuticals for the treatment of infectious diseases, cardiovascular diseases, inflammatory and autoimmune diseases, bronchopulmonary diseases, metabolic disorders, and in the fields of virology, oncology, hematology, dermatology, and neurology. The Diagnostics division engages in developing and marketing tools for research in genomics and proteomics, test methods for viruses such as HIV and HCV, integrated laboratory workstations, and devices for patients' own use. Its products are delivered through its affiliates all over the world.

Roche Vitamins and Fine Chemicals division is a bulk supplier of vitamins and carotenoids to the feed, food, pharmaceutical, and cosmetic industries. Its products include medicinal feed additives, amino acids, polyunsaturated fatty acids, feed enzymes, sunscreens, and emulsifiers. Let us look at the brief history of Roche since its foundation.

1896: F. Hoffmann-La Roche & Co. is founded in Basel, Switzerland.

1919: The company goes public.

1960: The company introduces Librium, a benzodiazepine tranquilizer that relieves tension without causing apathy.

1963: The company introduces Valium and it exceeds Librium in popularity.

1986: The company releases Roferon-A, a treatment for rare forms of cancer.

1990: The company restructures into divisions; Roche purchases a majority shareholding in California's leading biotech company, Genentech, Inc.

1994: The company acquires Syntex Corporation, which becomes Roche Bioscience, a major R&D development site.

1998: Franz Humer becomes chief executive officer.

1999: Roche inaugurates a new R&D facility in Basel.

2000: Roche spins off its Fragrances and Flavors division as a new company, called Givaudan.

2001: Roche acquires Amira Medical, a corporation active in diabetes monitoring, disposes Laboratory Corporation of America Holdings, acquires majority interest in Chugai Pharmaceutical Co., Ltd., Tokyo, Japan, and Amira Medical Inc., Scotts Valley, California

2002 Disposal of Vitamins and Fine Chemicals

2003 Acquires Disetronic AG, Burgdorf, Switzerland (injection pumps)

2004 Disposal of Roche Consumer Health(over-the-counter drugs)

2005 Acquires GlycArt Biotechnology AG, Schlieren, Switzerland

2007 Acquires BioVeris Inc., Gaithersburg, Maryland, USA (immunochemistry), NimbleGen Inc., Madison, USA (DNA microarrays), 454 Life Sciences Inc., Branford, USA (DNA sequencing), and Therapeutic Human Polyclonals Inc., USA (therapeutic antibodies)

2008 Acquires Ventana Medical Systems Inc., Tucson, USA (diagnostics, histopathology), Mirus Bio Corporation, Madison, USA (gene therapy), and Arius Research Inc., Toronto,

Canada (antibody therapy)

2009 Acquired Genetechin which it held a majority sketch since 1990.

Products

  • Pharmaceuticals: Roche has brought many highly effective drugs onto the market and is a world leader in innovative cancer drugs. Other areas include viral infections, metabolic, central nervous system disorders and inflammatory diseases.
  • Diagnostics: As the world leader in in-vitro diagnostics, we supply a wide range of rapid, reliable instruments and tests for disease screening and diagnosis in laboratories, at the point of care, and for patient self-management.
  • Product for researchers: Roche Applied Science supplies a broad array of instruments and highly specific reagents and test kits for use in the diverse research market.
  • The portfolio is especially strong in genomics and proteomics.




Pipeline



Roche has one of the youngest pipelines in the industry. I give here the following from the annual report of Roche.

430406127.jpg

55092267.jpg

1385321732.jpg

Sales

Let us look at the history of sales of Roche.

1203551811.jpg

If we concentrate on the last 10 years the sales growth is not extremely impressive. Furthermore, due to strong appreciation of CHF in the last year, the sales growth has been negative. Let us look at the data

660514482.jpg

Even with the negative sales growth the EPS growth is positive.

The growth of sales in the last 10 years has not been too stellar. In 2001, Roche had 29b of sales and in 2010 the number stood at 49b. This is an average growth rate of 5%.

Sales risk I: few drugs contributing the most of the sales. This is not the case with Roche. Here are some of the drugs with > 1bn of sales. As you see, the portfolio is quite diverse.

222229067.jpg

[/b]Sales risk II: Geographical risk. An adverse competition in one of the countries can effect the sales too much ? This is again not the case with Roche. Roche has a very diverse and global operation.

804922841.jpg

1158827241.jpg

[b]

Shares


The Company has a share capital of CHF 160,000,000, divided into 160,000,000 fully paid bearer shares with a nominal value of 1 Swiss franc each. There are no limitations on the transfer of these shares and no shares with maximum voting rights.

In addition, 702,562,700 non-voting equity securities have been issued in bearer form. They are not part of the share capital and confer no voting rights. However, each non-voting equity security does confer the same rights as any one of the shares numbered 1–160,000,000 to participate in the available earnings and in any remaining proceeds from liquidation following repayment of the share and the participation certifi- cate (PC) capital.

All shares in the Company are bearer shares, and for this reason the Company does not keep a register of shareholders. The following figures are based on information from shareholders, the shareholder validation check at the Annual General Meeting and on other information available to the Company.
  • 80,020,000 (previous year 80,020,000) shares: Shareholders’ group with pooled voting rights, comprising Ms Vera Michalski-Hoffmann, Ms Maja Hoffmann, Mr André Hoffmann, Dr Andreas Oeri, Ms Sabine Duschmalé-Oeri, Ms Catherine Oeri, Ms Maja Oeri, Mr Jörg Duschmalé and Mr Lukas Duschmalé. a)
  • 53,332,863 (previous year 53,332,863) shares (participation below 33 1/3%): Novartis International Ltd, Basel including Affiliates thereof.
  • Board of directors and executive committee hold (586+148)k non-voting shares together.
It is nice to see that the business remains family owned and the pool has nearly 50% of the voting rights.

Debt

The company has 27b of debt. A year back it had 36b, which was mainly a result of the Genetech acquisition. The Group continued to pay down the debt issued in the first half of 2009 to finance the Genentech transaction, with a further 3.1 billion Swiss francs of bonds and notes repaid in the first half of 2011. It is nice to see that management is on the job and is aggressively reducing debt. The current ratio stands at 1.61 and the quick ratio at 1.11 in the most recent quarter. The company has 10b in cash on its balance sheet. With 11b in FCF, I am not too worried at the moment.

1419811641.jpg

Profitability

Looking at the last 10 year of data, Roche seems to be very stable in maintaining its margins. I see no reason to worry here.

46843650.jpg

Cash flow

‘01‘02‘03‘04‘05‘06‘07‘08‘09‘10TTM
Free Cash Flow/Sales %10.11-3.8915.9915.9618.7415.5616.9718.8727.1623.7426.68
Free Cash Flow/Net Income0.800.291.630.750.990.860.841.011.781.351.47


Dividend

1860655547.jpg

Industry comparison

Valuation

CompanyRocheNovartisSanofi-Aventis
P/E14.513.917.2
P/S2.62.52.1
P/B13.92.21.3
PEG-1.83.7
P/CF8.310.67.2
Yield4.7%3.4%4.4%


Return on Invested Capital

660740119.jpg

Growth (5y average)

452656634.jpg

Valuation

In the last year the FCF of Roche was 11.6b (see table). Let us assume now growth rate, then in five years with a discount of 8% Roche will generate

11+11/1.08+11/1.082+11/1.083+11/1.084=50b

in cash. With different discount rates the results are listed in the table below.

Discount rate8%10%12%15%
0% growth+50b+48b+47b+45b


What should we use as the current value of Roche ? The current book value of 11 seems too small to me, especially for a pharma company with 50b in sales, the current valuation of 11b (there are< 1b shares outstanding) according to the book value is definitely too ridiculous to base our calculations on. So, if we do not go with the book value, what should we base our calculations on ? For a pharma company of this magnitude, I will say that a Price/Sales ratio of 2 is pretty conservative, which translates to 100b or chf100/share. Adding the calculations above we see that the company is easily worth 150chf/share with 0% growth in FCF if at manages to have the same FCF for only 5 years and earns nothing after that.

Now let us answer a few questions and see if Roche survives the checklist I have for a long term value holding.

Does the company have a moat ? Will it be around here for another 100 years ?

The company was started in 1896. It has seen countless recessions, two world wars and many CEOs. To survive such a long time is a feat in itself. The company has a strong portfolio with many drugs/molecules in different stages of trials. It also is comforting to know that the founding family owns around 50% of the voting rights and Novartis owns another 33%. Novartis has previously made an attempt at acquiring Roche and was foiled by the family pool.

Who is the CEO ?

The CEO of Roche (Dr Severin Schwan), it is nice to see, started his career as trainee in corporate finance for Roche in 1993. He has risen from there to his current position of CEO in 1998. He took over the position of the company when Roche was facing setbacks and the shares have gone from chf241 in 2007 to now chf142. I do not have necessary background to judge him at the moment.

Will the company grow ?

This is a tough one to answer. The recent rise in swiss franc has made the growth negative. In local currencies the growth is around 7%. The company raised dividends by 10% last year and expects to do the same this year. But if you look at the valuation, even if there is no growth, the company looks cheap. With such a huge portfolio of drugs (376 in phase I and II and 39 in Phase 3 or filing), I am certain the company will perform well.



Are there significant risks associated with the company ?


Bankruptcy - no. Credit risk - with 1.11 quick ratio, 11b in fcf and 10b in cash, I don’t think this risk exists at the moment. The company has done phenomenally well in maintaining its cap-ex around 4b. Major drugs and patent cliff - no. Roche has a few major drugs, Avastin (6.4b sales), Rituxan (6.3b sales), Herceptin (5.4b sales), Pegasys (1.6b sales) and Lucentis and Traxeda (1.4b sales). Roche, however, has one of the youngest pipelines in the industry. Its biggest drugs - MabThera/Rituxan, Avastin, and Herceptin - accounted for large portion of annual revenues and have patent protection through 2015, 2019, and 2019, respectively. The only major drug for which the company is losing revenue due to pricing pressure (both from branded competition and generics) is the anemia drug NeoRecormon/Epogin.

When would I consider buying more ?

I already own around 5k chf of Roche at an average price of 135chf. I would consider buying more if the share price drops below chf130.

About the author:

Chandan Dubey
I invest because I want to be free by the time I reach 40 years of age i.e., 2025. My investment style is to find a small number of bets with large margins of safety. I pay a lot of attention to management and their incentive. Ideally, I like to buy owner operator businesses. I am fortunate to have a strong inclination towards studying. I aid my financial understanding by extensive reading in psychology, economic, social sciences etc.

Rating: 4.3/5 (18 votes)

Comments

tonyg34
Tonyg34 - 2 years ago
Since I can, I will ask a couple of questions b/c I'm interested to get your take and see if your response differs from mine...

1) What's your take on Blue Cross Blue Shield refusing to cover Avastin for breast cancer. This is a billion dollar drug that just got nixed by a really important insurer. Yeah only 3 regional insurers made this choice but Blue Cross is a really big deal in the US. Also, does this have any implications about costs to get drugs approved in multiple markets? For example will companies have to go thru FDA process in US and then pay to get approved in EU, and again in Asia? Now that central gov't are trying to control health care costs its at least possible. Roche bought Genentech for Avastin so they could be #1 in cancer, is that top spot potentially threatened?

2) Roche dropped out of RNAi therapeutics about a year ago. Of the drugs in pipeline are any of them involved in areas that are involved with emerging technologies that are likely to get dropped (specifically Genentech drugs)? In other words, how confidently can you value the pipeline

3) Roche has a rock star pipeline, but we are paying up for that pipeline. And this tails into my big philosophical question for you,

since efforts by cash-strapped European and American governments to control health-care spending will likely result in:

1) higher costs associated with proving the safety of new treatments will result in additional costs for patents pending, as the government moves to reduce its liabilities.

2) the length of time in which new drugs are protected under patent will be put under constant pressure by government subsidized health care programs needing to reduce costs in order to stay solvent.

Therefore the expected returns on investment for companies in the health care sector will shrink as they cope with higher development costs and greater generic competition. This scenario has already been realized in the European anti-bacteria drug market (in the interest of public health, of course) and it stands to reason that it will slowly breech other market segments as well.

Therefore, is it worth spending up to own Roche's pipeline? Since drugs and devices are under the gun maybe we could look at consumables like BDX and TMO or services like CRL?

4) Roche isn't immune from the threat of generic rivals. Two key drugs – Herceptin (2014) and Rituxan(2013) – lose patent protection in Europe in the next two years. 2019 and 2016 in the US

5) Any guidelines on what Zelboraf might be worth?

If you choose to take these questions seriously and answer any of them...

Thank you for your time and consideration, I've done nothing to deserve it.

cdubey
Cdubey premium member - 2 years ago
Let me answer your questions one by one.

1 After digging deeper the facts are as follows

- Blue shield has refused coverage for breast cancer. With 3.2 million members, Blue Shield appears to be the largest health insurer so far to stop covering Avastin for breast cancer. Mediclaim still covers it.

- FDA advisory panel's gave an unanimous determination in June that Avastin is ineffective and unsafe for advanced breast cancer

- The FDA has not made a final decision on this. If FDA follows through the recommendation then this can cost Roche $1b (estimated) loss in sales, out of $6.5b Avastin brings in.

- Less than a month after the FDA panel's 6-0 vote, a group representing the country's leading cancer centers voted 24-0 to maintain its position recommending Avastin for breast cancer when used with the chemotherapy drug paclitaxel.

- Avastin is also used in treating Colorectal, Lung, Kidney cancers and some forms of brain tumor.

Worst case, $1b loss in sales, estimated. Maybe $2b. This is 4% of sales of Roche. I would not panic over this.

2 Roche pulled out of RNAi and it seems it plans to spin-off or sell its assets. Roche has spun off Basliea in a similar situation in 2000. Drugs in the early stages of the pipeline don't pan out anyway. Only 10% survive. I would not attempt to judge the pipeline as this can't be done with a lot of certainty. The whole idea of having different experiments/phase/trials is to verify that the drug works in the way scientists think they should work. Nobody knows if a particular drug will survive the next stage or not. Well, that is a bit strong but I will stick with it. The experiments are the proof, before it even the scientists don't know. Roche spends a lot on R&D, close to $5b/year, the whole bill in the RNAi field was a bit over $1b since 2007.

4 You are right. Digging up, I quote from a reuters article

The company has 50 new experimental drugs in clinical trials, with nearly 20 undergoing late-stage testing, including the breast cancer drugs T-DM1 and pertuzumab and cholesterol medication dalcetrapib. But many of Roche's cancer drugs are difficult to copy, making the generic threat fairly mild.[/i]

I can't verify this. But maybe there is hope. Maybe they will able to extend the patents or maybe not. But if one looks a LLY, BMY, Pfizer, Novartis, they have worse patent cliffs to take care of. Roche is in a much better place in this sense.

5 Roche claims that it will have annual sales topping $1b.

[i]Both (Yervoy and Zelboraf) are expected to top $1 billion in sales for their manufacturers, and analysts at Sanford Bernstein predict that Yervoy will capture 60 percent of the U.S. market versus 40 percent for Zelboraf.


My investing philosophy can be succinctly represented as follows:

  • Find companies with a record of good performance — this is shown through earnings, solid free cash flow, and strong management. Also, this is harder to do but get a feel of the company and see that the above prospects are not diminished going forward. Hold these companies for years.
  • Once you find such a company, buy shares consistently — reinvest dividends, do not panic, do not sell. Do this for the rest of your life.[/list]

    Roche fits the bill perfectly. Look at the FCF, earnings, management and you will like the company more and more.
  • Please leave your comment:


    Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
    GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)
    Free 7-day Trial
    FEEDBACK
    Email Hide