Wednesday 21 March 2018

Roche's secret: keep up the research funding

Share watch with John Lynch

'These days the Roche challenge is to deliver value and innovation in an environment of reduction in government spending and cost containment'
'These days the Roche challenge is to deliver value and innovation in an environment of reduction in government spending and cost containment'

John Lynch

Drive less than three kilometres through the beautiful Swiss city of Basel and you will pass the world headquarters of not one, but two of the great life science companies - Novartis and the company we are putting under the microscope this morning, Roche AG.

Roche trails Novartis in revenue but is still the third largest life science company in the world. It is also regarded as one the best performing in its sector over the last decade. Like the rest of the sector, Roche is facing formidable challenges but unquestionably has the muscle to compete in a rapidly changing world.

Founded in 1896 by Fritz Hoffmann la Roche, the company prospered until World War I, when it almost went bankrupt following the German boycott of its products and the loss of its main production plant in Germany. Its survival was helped in no small way by the development of a synthetic vitamin C.

By the late 1960s it had dabbled in cosmetics (Pantene), developed a portfolio of anti-depressants and set up a diagnostic division. In the early part of the current millennium it divested itself of fragrances and vitamins to focus on pharmaceuticals and diagnostics. Roche employs 88,500 and has a market cap of CHF 220bn (€202bn), producing prescription drugs and manufacturing diagnostic products.

These days the Roche challenge is to deliver value and innovation in an environment of reduction in government spending and cost containment. At the same time, due to major gains in life expectancy, governments around the world are facing increased healthcare demands and costs. Clearly both R&D and innovation are high on the agenda. Last year, the company spent a considerable CHF 9bn on research, finding approval for 11 new pharma products and launching 14 new diagnostic products.

The pharmaceutical division is Roche's largest and most profitable, with sales of CHF38bn, profits at CHF18bn with margins of 40pc on sales. Results were driven by its oncology portfolio which accounts for 60pc of pharma sales with key products like Abastin, Hercaptan and Rituxan. Last year, sales grew in all regions particularly in the US and Europe. Interestingly, the increased healthcare spending in emerging markets is also helping Roche sales. Ten years ago China ranked ninth in the world in healthcare spending, today it is ranked second.

Roche diagnostic division sales last year were CHF10bn with operating profits of CHF2bn but margins on sales were a low 20pc. Overall sales increased by 6pc, helped by demand in China, Latin America and Asia-Pacific. However, sales in the critical US market were 'challenging' due to Medicare regulation changes. Chugai, the company's Japanese operation, saw sales fall 9pc. An interesting feature of the diagnostic market is increasing regulation particularly in Europe, US and China. Roche apparently knows enough about regulation to see this as a positive. Last year, the group posted increased sales of CHF47.5bn. Half-year reports were positive with group sales up 6pc to CHF24bn. Roche shares are trading in the mid CHF250 range below its 10-year high of CHF290 earlier this year and has an elevated price earnings multiple of 24. Almost 120 years after its formation the family still plays a role in the company and controls half of its shares.

Interestingly, Novartis holds one-third of Roche shares following a failed bid 15 years ago. Investors were nervous when in January of this year the Swiss Central Bank stopped supporting the exchange rate, relative to the euro. The market fell but the value of the Swiss Franc increased so investors breathed a sigh of relief. For Roche the impact is not significant as less than 20pc of its costs are in Switzerland.

In light of the frenzied M&A in the sector recently, investors were pleased when the company announced it is to avoid any mega purchases but will continue with bolt-ons, spending almost CHF10bn last year. Roche's shares remain a quality hold and attractive in the present flakey markets.

Nothing in this section should be taken as a recommendation, either explicit or implicit to buy any of the shares mentioned.

Irish Independent

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