Roche Investors Should Breathe Easier After InterMune Acquisition

NEW YORK (TheStreet) -- On Sunday, Swiss drugmaker Roche Holding (RHHBY) answered the all-important question investors have always posed to management: What's up with the non-oncology pipeline?

Roche finally responded by announcing it had picked off InterMune (ITMN) , a company that specializes in drugs to treat fatal lung disease. The all-cash deal valued at $8.3 billion is the latest in a string of drug M&A activity as companies look to strengthen and,  in some cases, diversify their current offerings.

Roche stock closed Friday at $36.32, down 0.33%. Shares have gained 6% on the year to date, almost half of the health care sector's 11% gain, according to Morningstar.

Roche's stock has grossly underperformed rivals like AstraZeneca (AZN) and Novartis (NVS) , which have posted gains of 39% and 12%, respectively. Even Johnson & Johnson (JNJ) has rewarded investors with close to 15% returns.

For Roche, whose shares have traded sideways since February, investors have wondered if there was any value left. Despite the relative underperformance in the shares, the stock was still expensive at a price-to-earnings ratio of 20.

Making matters worse, until Sunday, management had done little to differentiate the company from the likes of, say, GlaxoSmithKline (GSK) , a company investors can buy at a much cheaper multiple of 13. And Glaxo pays a 5.3% yield compared to no dividend for Roche.

This deal for InterMune, however, changes the landscape.

In InterMune, Roche saw an opportunity it couldn't pass up, even at a 38% premium to InterMune's most recent closing price. It's not a cheap deal. What I think is more important to consider, though, is the value InterMune will bring -- whether on its own strengths or as a value-add to Roche's reparatory assets in Xolair (used to treat asthma) and Pulmozyme (used to treat cystic fibrosis).

Before this deal, there was nothing extraordinary about Roche's respiratory business. Roche has thrived mainly on its strength in cancer treatments. While the company's oncology position remains strong, the likes of Merck (MRK) and Bristol-Myers Squibb (BMY) are threatening Roche's market share, which is why InterMune is such an important deal.

InterMune has a drug, pirfenidone, that treats deadly scarring of the lungs, also known as idiopathic pulmonary fibrosis. The drug has been granted approval in both Canada and Europe and has sold well in those markets. In the most recent quarter, pirfenidone, which sells in Europe under the name Esbriet, generated $35.7 million in revenue.

And with pirfenidone receiving positive results in a recent phase III study, industry experts believe the drug will also be granted approval by the Food and Drug Administration as early as November. Assuming the drug gets approved, it would complement Roche's portfolio, currently including Rituxan, Avastin and Herceptin, which are growing at mid- to high single digits.

What's more, back in July, the company disappointed investors with unfavorable data on crenezumad, which was being tested to treat Alzheimer's. The company hasn't given up, however. To the extent Roche can use its strong research and development budget to generate higher efficacy for crenezumad while also expanding its oncology pipeline, investors should do well. But these are big "ifs."

What we do know is the company just delivered an almost three-point jump in first-half gross margin, which boosted operating income by 7%. Management has not lost sight of the bottom line. And extracting value from InterMune, though it will take time, will be a priority.

But for now, investors can breathe a little easier knowing that management is holding firm to its promise to use capital to drive long-term value.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

Follow @Richard_WSPB

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Now let's look at TheStreet Ratings' take on some of these stocks.

TheStreet Ratings team rates INTERMUNE INC as a Sell with a ratings score of D-. TheStreet Ratings Team has this to say about their recommendation:

"We rate INTERMUNE INC (ITMN) a SELL. This is driven by some concerns, which we believe should have a greater impact than any strengths, and could make it more difficult for investors to achieve positive results compared to most of the stocks we cover. Among the areas we feel are negative, one of the most important has been generally deteriorating net income."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • The company, on the basis of change in net income from the same quarter one year ago, has underperformed when compared to that of the S&P 500 and greatly underperformed compared to the Biotechnology industry average. The net income has decreased by 13.2% when compared to the same quarter one year ago, dropping from -$62.87 million to -$71.19 million.
  • The company's current return on equity greatly increased when compared to its ROE from the same quarter one year prior. This is a signal of significant strength within the corporation. Compared to other companies in the Biotechnology industry and the overall market, INTERMUNE INC's return on equity significantly trails that of both the industry average and the S&P 500.
  • The gross profit margin for INTERMUNE INC is currently very high, coming in at 86.07%. Regardless of ITMN's high profit margin, it has managed to decrease from the same period last year. Despite the mixed results of the gross profit margin, ITMN's net profit margin of -199.20% significantly underperformed when compared to the industry average.
  • INTERMUNE INC has improved earnings per share by 7.7% in the most recent quarter compared to the same quarter a year ago. The company has demonstrated a pattern of positive earnings per share growth over the past year. However, we anticipate underperformance relative to this pattern in the coming year. During the past fiscal year, INTERMUNE INC continued to lose money by earning -$2.74 versus -$2.84 in the prior year. For the next year, the market is expecting a contraction of 1.6% in earnings (-$2.78 versus -$2.74).
  • Net operating cash flow has slightly increased to -$52.59 million or 6.33% when compared to the same quarter last year. Despite an increase in cash flow of 6.33%, INTERMUNE INC is still growing at a significantly lower rate than the industry average of 100.59%.
TheStreet Ratings team rates ASTRAZENECA PLC as a Buy with a ratings score of B. TheStreet Ratings Team has this to say about their recommendation:

"We rate ASTRAZENECA PLC (AZN) a BUY. This is driven by several positive factors, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its revenue growth, largely solid financial position with reasonable debt levels by most measures, solid stock price performance, good cash flow from operations and expanding profit margins. We feel these strengths outweigh the fact that the company has had somewhat disappointing return on equity."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • The revenue growth came in higher than the industry average of 4.6%. Since the same quarter one year prior, revenues slightly increased by 7.3%. This growth in revenue does not appear to have trickled down to the company's bottom line, displayed by a decline in earnings per share.
  • The current debt-to-equity ratio, 0.46, is low and is below the industry average, implying that there has been successful management of debt levels.
  • Compared to its closing price of one year ago, AZN's share price has jumped by 46.55%, exceeding the performance of the broader market during that same time frame. Regarding the stock's future course, although almost any stock can fall in a broad market decline, AZN should continue to move higher despite the fact that it has already enjoyed a very nice gain in the past year.
  • Net operating cash flow has increased to $2,079.00 million or 29.45% when compared to the same quarter last year. The firm also exceeded the industry average cash flow growth rate of -1.19%.
  • The gross profit margin for ASTRAZENECA PLC is currently very high, coming in at 91.52%. It has increased significantly from the same period last year. Regardless of the strong results of the gross profit margin, the net profit margin of 11.57% trails the industry average.
TheStreet Ratings team rates NOVARTIS AG as a Buy with a ratings score of A-. TheStreet Ratings Team has this to say about their recommendation:

"We rate NOVARTIS AG (NVS) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its revenue growth, increase in stock price during the past year, reasonable valuation levels, increase in net income and good cash flow from operations. We feel these strengths outweigh the fact that the company has had somewhat disappointing return on equity."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • NVS's revenue growth has slightly outpaced the industry average of 4.6%. Since the same quarter one year prior, revenues slightly increased by 2.1%. This growth in revenue appears to have trickled down to the company's bottom line, improving the earnings per share.
  • The stock has risen over the past year as investors have generally rewarded the company for its earnings growth and other positive factors like the ones we have cited in this report. Turning our attention to the future direction of the stock, it goes without saying that even the best stocks can fall in an overall down market. However, in any other environment, this stock still has good upside potential despite the fact that it has already risen in the past year.
  • The net income growth from the same quarter one year ago has exceeded that of the S&P 500 and greatly outperformed compared to the Pharmaceuticals industry average. The net income increased by 1.6% when compared to the same quarter one year prior, going from $2,516.00 million to $2,555.00 million.
  • Net operating cash flow has increased to $3,340.00 million or 32.69% when compared to the same quarter last year. The firm also exceeded the industry average cash flow growth rate of -1.19%.
TheStreet Ratings team rates JOHNSON & JOHNSON as a Buy with a ratings score of A+. TheStreet Ratings Team has this to say about their recommendation:

"We rate JOHNSON & JOHNSON (JNJ) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its revenue growth, largely solid financial position with reasonable debt levels by most measures, increase in stock price during the past year, growth in earnings per share and increase in net income. Although no company is perfect, currently we do not see any significant weaknesses which are likely to detract from the generally positive outlook."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • The revenue growth came in higher than the industry average of 4.6%. Since the same quarter one year prior, revenues slightly increased by 9.1%. Growth in the company's revenue appears to have helped boost the earnings per share.
  • JNJ's debt-to-equity ratio is very low at 0.22 and is currently below that of the industry average, implying that there has been very successful management of debt levels. To add to this, JNJ has a quick ratio of 1.80, which demonstrates the ability of the company to cover short-term liquidity needs.
  • The stock has risen over the past year as investors have generally rewarded the company for its earnings growth and other positive factors like the ones we have cited in this report. Turning our attention to the future direction of the stock, it goes without saying that even the best stocks can fall in an overall down market. However, in any other environment, this stock still has good upside potential despite the fact that it has already risen in the past year.
  • JOHNSON & JOHNSON has improved earnings per share by 13.5% in the most recent quarter compared to the same quarter a year ago. The company has demonstrated a pattern of positive earnings per share growth over the past two years. We feel that this trend should continue. During the past fiscal year, JOHNSON & JOHNSON increased its bottom line by earning $4.82 versus $3.87 in the prior year. This year, the market expects an improvement in earnings ($5.92 versus $4.82).
  • The net income growth from the same quarter one year ago has exceeded that of the S&P 500 and greatly outperformed compared to the Pharmaceuticals industry average. The net income increased by 12.9% when compared to the same quarter one year prior, going from $3,833.00 million to $4,326.00 million.
TheStreet Ratings team rates GLAXOSMITHKLINE PLC as a Buy with a ratings score of B. TheStreet Ratings Team has this to say about their recommendation:

"We rate GLAXOSMITHKLINE PLC (GSK) a BUY. This is driven by some important positives, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its notable return on equity and expanding profit margins. We feel these strengths outweigh the fact that the company has had sub par growth in net income."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • The company's current return on equity greatly increased when compared to its ROE from the same quarter one year prior. This is a signal of significant strength within the corporation. Compared to other companies in the Pharmaceuticals industry and the overall market, GLAXOSMITHKLINE PLC's return on equity significantly exceeds that of both the industry average and the S&P 500.
  • GLAXOSMITHKLINE PLC's earnings per share declined by 26.1% in the most recent quarter compared to the same quarter a year ago. This company has reported somewhat volatile earnings recently. But, we feel it is poised for EPS growth in the coming year. During the past fiscal year, GLAXOSMITHKLINE PLC increased its bottom line by earning $3.68 versus $2.92 in the prior year. This year, the market expects an improvement in earnings ($97.65 versus $3.68).
  • Regardless of the drop in revenue, the company managed to outperform against the industry average of 4.6%. Since the same quarter one year prior, revenues slightly dropped by 1.3%. Weakness in the company's revenue seems to have hurt the bottom line, decreasing earnings per share.
  • The gross profit margin for GLAXOSMITHKLINE PLC is currently very high, coming in at 70.72%. Regardless of GSK's high profit margin, it has managed to decrease from the same period last year. Despite the mixed results of the gross profit margin, the net profit margin of 11.43% trails the industry average.
  • The share price of GLAXOSMITHKLINE PLC has not done very well: it is down 8.03% and has underperformed the S&P 500, in part reflecting the company's sharply declining earnings per share when compared to the year-earlier quarter. Looking ahead, although the push and pull of the overall market trend could certainly make a critical difference, we do not see any strong reason stemming from the company's fundamentals that would cause a continuation of last year's decline. In fact, the stock is now selling for less than others in its industry in relation to its current earnings.
TheStreet Ratings team rates MERCK & CO as a Buy with a ratings score of A. TheStreet Ratings Team has this to say about their recommendation:

"We rate MERCK & CO (MRK) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its solid stock price performance, increase in net income, largely solid financial position with reasonable debt levels by most measures, reasonable valuation levels and growth in earnings per share. We feel these strengths outweigh the fact that the company shows weak operating cash flow."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • Compared to where it was a year ago today, the stock is now trading at a higher level, reflecting both the market's overall trend during that period and the fact that the company's earnings growth has been robust. Looking ahead, unless broad bear market conditions prevail, we still see more upside potential for this stock, despite the fact that it has already risen over the past year.
  • The net income growth from the same quarter one year ago has significantly exceeded that of the S&P 500 and the Pharmaceuticals industry. The net income increased by 121.2% when compared to the same quarter one year prior, rising from $906.00 million to $2,004.00 million.
  • The current debt-to-equity ratio, 0.48, is low and is below the industry average, implying that there has been successful management of debt levels. Along with the favorable debt-to-equity ratio, the company maintains an adequate quick ratio of 1.14, which illustrates the ability to avoid short-term cash problems.
  • MERCK & CO reported significant earnings per share improvement in the most recent quarter compared to the same quarter a year ago. This company has reported somewhat volatile earnings recently. But, we feel it is poised for EPS growth in the coming year. During the past fiscal year, MERCK & CO reported lower earnings of $1.46 versus $2.00 in the prior year. This year, the market expects an improvement in earnings ($3.50 versus $1.46).
TheStreet Ratings team rates BRISTOL-MYERS SQUIBB CO as a Buy with a ratings score of B. TheStreet Ratings Team has this to say about their recommendation:

"We rate BRISTOL-MYERS SQUIBB CO (BMY) a BUY. This is driven by a number of strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its largely solid financial position with reasonable debt levels by most measures, reasonable valuation levels, notable return on equity, increase in stock price during the past year and expanding profit margins. We feel these strengths outweigh the fact that the company has had sub par growth in net income."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • The current debt-to-equity ratio, 0.50, is low and is below the industry average, implying that there has been successful management of debt levels. Along with the favorable debt-to-equity ratio, the company maintains an adequate quick ratio of 1.15, which illustrates the ability to avoid short-term cash problems.
  • Current return on equity exceeded its ROE from the same quarter one year prior. This is a clear sign of strength within the company. Compared to other companies in the Pharmaceuticals industry and the overall market on the basis of return on equity, BRISTOL-MYERS SQUIBB CO has underperformed in comparison with the industry average, but has exceeded that of the S&P 500.
  • Compared to where it was a year ago today, the stock is now trading at a higher level, regardless of the company's weak earnings results. Looking ahead, unless broad bear market conditions prevail, we still see more upside potential for this stock, despite the fact that it has already risen over the past year.
  • BRISTOL-MYERS SQUIBB CO's earnings per share declined by 37.5% in the most recent quarter compared to the same quarter a year ago. This company has reported somewhat volatile earnings recently. But, we feel it is poised for EPS growth in the coming year. During the past fiscal year, BRISTOL-MYERS SQUIBB CO increased its bottom line by earning $1.55 versus $1.15 in the prior year. This year, the market expects an improvement in earnings ($1.80 versus $1.55).

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