Pricing Power and New Product Flow as a Basis for Biopharma Stock Selection

Richard
Print Friendly
Share on LinkedIn0Tweet about this on Twitter0Share on Facebook0

SEE END OF THIS REPORT FOR IMPORTANT DISCLOSURES

Richard Evans / Scott Hinds / Ryan Baum

203.901.1631 /.1632 / .1627

revans@ / shinds@ / rbaum@ssrllc.com

@SSRHealth

July 16, 2017

Pricing Power and New Product Flow as a Basis for Biopharma Stock Selection

  • In years past, rates of biopharma ‘same basket’ net price inflation were greater, and rates of inflation were reasonably similar across companies. Net price inflation is now slowing, making new product flow an even larger percentage of growth; because new product flow is so varied by company, growth rates across companies should become increasingly diverse, further emphasizing new product flow as a basis for stock selection
  • US net pricing (and by extension WW pricing) gains have slowed in large part because of increasingly aggressive formulary actions; because these actions hit some companies hard and other companies not at all, rates of net pricing should increasingly vary across companies, emphasizing pricing power as a companion (to product flow) basis for stock selection
  • Following this logic, and using proprietary datasets geared to tracking net pricing and identifying undervalued product pipelines, we developed a screen for companies with what appear to be optimal combinations of pricing ‘stability’ (because companies are unlikely to accelerate same basket pricing gains, but are at risk of outright declines in net pricing, we screen for the ability to defend current rates of net price growth), and undervalued product flow
  • BMY, LLY, Roche, SNY and VRTX all meet our criteria for having either major products with pending PDUFA dates or undervalued product pipelines, and for being relatively unlikely to see negative trend breaks in US net pricing. SNY comes with the caveat of being exposed to ongoing declines in US long-acting insulin prices; Roche comes with the added benefit of having an approved new product (Ocrevus) which we believe has considerably greater potential than is reflected in either share price, or consensus

Growth = pricing power and new product flow

Simplistically, pharmaceutical sales growth is the product of growth in population, growth in ‘doses’ per person, and growth in dollars per dose. Growth in population affects all biopharma companies more or less equally, as do the aging and elasticity components of growth in doses per person – everything else varies by company. Some portion of growth in doses per person is driven by innovation, which of course affects some companies more than others. Growth in dollars per dose is the combination of pricing power and new product flow, both of which are hugely varied by company

Because pricing power and product flow are the largest drivers of biopharma revenue growth (Exhibit 1) and are highly varied by company (Exhibits 2, 3), it stands to reason that relative rates of sales and earnings growth for biopharma stocks will be dictated by these two variables. By extension, relative share price performances of biopharma stocks should be dictated by unanticipated changes in pricing power and product flow. The point of this note is to screen for companies who are most likely to surprise positively on product flow, and least likely to surprise negatively on pricing

Pricing – outlook is defensive

For our immediate purposes we’re treating pricing as the rate of net price inflation achieved on a same basket basis, i.e. without regard to the impact of new product launches on a company’s average selling price. Biopharma companies have little or no ‘same basket’ net pricing power outside the US, so our analysis focuses on US net pricing trends

The overall US net pricing trend is decelerating, reflecting the fact that US biopharma pricing power is more of a defensive than an offensive consideration – few if any companies have a reasonable prospect of meaningfully accelerating their rates of US net pricing gain, but more than a few face the risk of losing their ability to grow net prices in real terms, or even seeing their real net prices decline. As is evident from recent examples, loss of US net pricing power can mean corresponding share price losses (Exhibits 4a thru 4d)




We sort companies according to net pricing by: 1) calculating companies’ relative rates of reliance on US net pricing gains for overall growth; and 2) analyzing which companies are most likely to lose US net pricing power

To scale companies’ relative rates of reliance on US net pricing, we simply calculate the percentage of trailing (12m) WW revenue growth attributable to US net pricing gains. Companies with higher percentages obviously are more reliant on US net price inflation for growth than companies with smaller, or negative[1] percentages. Exhibit 5 shows each company’s trailing 12m rate of WW revenue growth as reported (grey column) and the rate (green column) that would have been achieved if the company’s rate of US net pricing gain had matched the average rate of US net pricing gains for peers. The black line in Exhibit 5 expresses the percent of trailing 12m WW revenue growth attributable to US net pricing gains

Exhibit 5 sorts companies with respect to their relative reliance on US net pricing gains for overall revenue growth, but says little about whether the companies can maintain these rates. Setting aside loss of exclusivity, sudden loss of net pricing power typically is a consequence of aggressive formulary action, which itself is a consequence of a given market category growing price too rapidly, and/or of new entrants in a market category enabling formulary managers to bid competitors against one another

We track changes in gross and net price by product, market category, and company on a quarterly basis for most US prescription brands[2]. This allows us to calculate which market segments are having the largest impact on total market net price inflation, which arguably points to the market segments where formulary managers are most likely to intervene. The logic is straightforward; formulary managers are motivated to limit the rate of net price inflation, and so are likely to focus their efforts on the market segments that are making the largest contributions to overall net price inflation

Exhibit 6[3] summarizes the market as of 1Q17; DMARDs, HIV, and MS account for most of total market net price growth, and so are logically the market segments most likely to draw formulary managers’ attention. Companies whose current net pricing power derives mainly from these market segments are ABBV (91% of US net pricing gains come from Humira, a DMARD), GILD (42% of US net pricing gains came from HIV products), GSK (66% of US net pricing gains came from HIV products) and BIIB (72% of US net pricing gains came from MS). Of these names ABBV and BIIB are the most reliant on US net pricing gains to drive WW revenue growth (Exhibit 5, again). GILD’s revenues are declining as demand for HCV products slows and as HCV prices creep lower; this belies the fact that GILD’s rate of revenue decline would have been much greater without the offset of mid-teens net pricing gains in the company’s HIV line

Product Flow – outlook is offensive

Where our perspective on pricing is more defensive (avoiding surprise loss of US net pricing power), our perspective on product flow is more offensive – in particular, we aim to find companies whose share prices fail to fully account for future product flows

We approach product flow in three overlapping and complimentary ways:

  1. in the short-term, we favor companies with major products pending regulatory approval, as these names typically outperform peers;
  2. in the medium-term, we favor companies for which consensus / share price fail to fully reflect revenue growth opportunities after accounting for product flow implied by the company’s level of clinical trial activity; and,
  3. in the medium- to longer-term, we favor companies whose patent portfolios imply a greater share of peer group innovation than is implied by the company’s share price

Companies with major[4] new product submissions before FDA tend to outperform in the period from regulatory filing to regulatory action date, with risks concentrated in the +/- 45 day period preceding the scheduled regulatory action. Because of this, all else equal we prefer to hold names in this window. This screen tends to pick up biopharma stocks across the entire capitalization range, and tends to over-select names at the lower end of the capitalization range, as products filed by these companies are more likely to have products that cross the threshold of being defined as ‘major’. Exhibit 3 summarizes filed product +3yr revenue consensus as a percent of total company +3yr revenue consensus for the 22 largest (by R&D spending) biopharma names. Since November of 2011, stocks held in these portfolios (which vary according to the threshold percent of +3yr consensus revenues attributable to the filed product; the ‘1%’, ‘5%’, and ‘20%’ portfolios are shown in Exhibit 7) have tended to produce higher returns than either the BTK or an index of stocks eligible for inclusion but not held long (Exhibit 7)

Consensus estimates capture only about two-thirds of companies’ active phase 3 projects, about one-sixth of active phase 2 projects, and about 1 percent of phase 1 projects (Exhibit 8). Using clinicaltrials.gov registry data we compile a comprehensive view of each company’s pipeline, and look for instances in which consensus and/or share price appear to more seriously underestimate one company’s pipeline relative to its peers. Exhibit 9 is a scatterplot of growth implied by the companies’ share prices v. growth implied by consensus supplemented with data from clinicaltrials.gov. On a back tested basis since April of 2013, a portfolio comprised of the three stocks whose share price implied growth most underestimated growth after accounting for clinicaltrials.gov data outperformed the remainder of the peer group (any of the 22 companies eligible but not identified as undervalued) by 2.8X (Exhibit 10)[5]

Our most comprehensive and proven means of pipeline valuation compares the portion of a company’s EV that cannot be explained by a DCF of its existing and phase 3 assets (which by definition is the EV of phase 2 and earlier assets), to a comprehensive analysis of all company patents that are associated with phase 2 and earlier assets. The analysis is done on a relative basis, e.g. if the EV of phase 2 and earlier assets for Company X is 2 percent of the combined EV of phase 2 and earlier assets for all companies analyzed, but Company X has 4 percent of the quality-adjusted phase 2 and earlier intellectual property across all companies analyzed, this implies that the phase 2 and earlier assets of Company X are 50% undervalued, relative to the average of the companies analyzed. If raising the total EV of Company X so that these percentages match implies more than a 20 percent increase in the share price of Company X, we view those shares as undervalued. Since April of 2013, stocks prospectively identified as undervalued on this basis have outperformed peers (any of the 22 companies eligible but not held long) by 2x on an equal-weighted basis (Exhibit 11). Exhibit 12 shows the percent change in EV necessary for companies’ relative valuations to match their relative shares of phase 2 and earlier intellectual property

Who’s best positioned: BMY, LLY, Roche, SNY and VRTX

Exhibit 13 (also shown on page 2) sorts the peer group according to both US net pricing reliance, and new product flow. Pricing reliance is measured by the percent of trailing 12m worldwide revenue growth attributable to US net pricing gains. Conservatively, we view companies within +/- 25 percentage points of the peer group median (14 percent) as having trailing revenue growth rates that are relatively unaffected by US net pricing. These 10 companies are highlighted with a green triangle in the first column of the chart – companies significantly higher or lower than the median are more heavily affected by US net pricing. In addition, companies with significant US net pricing exposure to at-risk categories are highlighted with a red triangle in the second column. New product flow is measured in terms of the near-term (pending PDUFA date); the mid-term (undervalued growth as measured with clinicaltrials.gov pipeline supplements); and the longer-term (undervalued Hidden Pipeline) in the third through fifth columns of Exhibit 13, respectively. For each, a company with a pending PDUFA date; or an undervalued pipeline by either the mid- or longer-term measures is flagged with a green triangle

The most attractive names in this analysis are those that offer all of (1) pricing stability; (2) limited exposure to categories at-risk of more aggressive formulary management; and (3) either imminent, or undervalued mid- to longer-term new product flow. By this criteria, BMY, LLY, Roche, SNY and VRTX offer the best combinations of pricing stability and new product flow. SNY comes with the caveat that it remains exposed to ongoing declines in long-acting insulin prices as biosimilars to Lantus gain share. Roche comes with the added benefit of significant upside potential for Ocrevus, relative to consensus[6]

Exhibits 14a through 14eshow the top- and bottom- product-level drivers of net price change for each of the five companies over the past four quarters and cumulatively over the past three years; as well as the year on year percent change in net price for each of those products[7]



exh14d_new

exh14e_new
Exhibit 15 details the 29 products in LLY’s pipeline that we identified from clinicaltrials.gov which lack sell-side analyst coverage

Exhibit 16 breaks out the Hidden Pipeline values for BMY, Roche, SNY and VRTX. Each of these companies’ share of the peer group’s aggregate Hidden Pipeline substantially exceeds its share of the peer group’s aggregate market value assigned to Hidden Pipelines. The relative share price performance which would bring the Hidden Pipeline market value to par with the peer group is in the shaded column

  1. Companies whose share of growth attributable to US net pricing is negative experienced net price declines over the trailing 12 months (i.e., declines in price caused reported WW revenue growth to be lower than implied by units/mix dynamics)
  2. Please see: “US Rx net pricing trend through 1Q17”, SSR Health LLC, June 6, 2017
  3. Top set of rows lists classes making largest net price contributions by quarter; 2nd set of rows shows percent of total market net price gain explained by each class; 3rd set of rows shows rate of net pricing growth for each class; 4th set of rows shows classes making largest negative contributions to the total market pricing trend; 5th set of rows shows the share of market net price change explained by each class; 6th set of rows shows rate of net price change for each class
  4. In this context a ‘major’ product is defined as one for which +3yr product consensus is at least 1 percent of total company +3yr consensus
  5. Please see: “Drug & Biotech Companies with Undervalued Pipelines: Updated View”, SSR Health LLC, June 12. 2017
  6. Please see: “Roche: The Bull Case for Ocrevus, and the Corresponding Bear Case for BIIB”, SSR Health LLC, May 1, 2017
  7. Top sets of rows list products making largest net price contributions to each respective company by quarter; 2nd sets of rows show rate of net pricing growth for each of these largest product contributors; 3rd sets of rows show products making largest negative contributions to each respective company; 4th sets of rows show rate of net price change for each of these largest negative product contributors

 

©2017, SSR, LLC, 225 High Ridge Rd, 2nd Floor, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein. The views and other information provided are subject to change without notice. This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. In the past 12 months, through a wholly-owned subsidiary SSR Health LLC has provided paid advisory services to Pfizer Inc (PFE), BioPharmX (BPMX), Gilead Sciences (GILD), Bristol-Myers Squibb (BMY) and Sanofi (SNY) on both securities-related and non-securities-related topics. One or more of SSR Health’s analysts owns long positions in the following stocks: ADMS, AERI, AMGN, BMY, DVA, FLXN, GILD, HRTX, INVA, KITE, MPSYY, NSTG, NVO, ONCE, PTCT, RHHBY, RIGL, SNPHY

 

Print Friendly