The stock closed down 4% given the over-performance since early 2017 and the lack of consensus upgrades after the results.
Vertex reported Q2/2017 Adjusted sales of $517M, 5% ahead of consensus expectation, while EPS were $0.39, approximately in line with consensus. FY 17 guidance has been reiterated related to Kalydeco ($740-770M of sales) and Orkambi ($1.1 – 1,3B), while the Opex guidance ($1.33-1.36B for R&D + SG&A vs. $1.25-1.30B) has been increased to reflect additional spending behind the development of the triple combo.
In summary, it’s unlikely that we will see any significant changes in the consensus numbers for Vertex after this reporting season.
Main takeaways from the quarter
The corporate signals from the Q2/2017 results have been really positive for two key reasons:
- The performance of the key growth drivers of Vertex has been really strong.
- The management’s tone during the conference call was very confident related to the ability to achieve the high end of the guidance related to the sales for the Cystic Fibrosis franchise.
Kalydeco sales were $190M, $7M higher than street expectations, driven by a solid performance in both US and EU, but mainly thanks to a positive stocking effect on inventory for $5M. The outlook for Kalydeco remains solid because Vertex has recently received the approval for the use in patients with cystic fibrosis with residual function mutations, which added around 900 additional patients to the target population for Kalydeco.
Orkambi sales were $324M, $20M higher than street expectations, driven by a solid performance in US after the label expansion into 6-11 year old patients, while the uptake in Europe seems still in the early phase. As I said in my previous article, the key upside risk for Orkambi in H2/2017 is the potential reimbursement approval in France, but there is still no clarity about the timing for the approval in France and in other EU countries.
We have made good progress in the first half of this year reaching pricing and reimbursement agreements in Germany, Ireland, Italy, Austria, Luxemburg and Denmark. And as you said, we’re in active negotiations with other countries, including France, the UK and the Netherlands. And where we are in those discussions, I’ll refer you back to the comments we’ve made previously, these discussions tend to have three phases. There’s a clinical benefit assessment, the pharmacoeconomic assessment, and then, you’re into the pricing discussions, and we’re through those first two. There’s really no debate in those markets in Europe about the clinical benefits of ORKAMBI. We’re really in the pricing and reimbursement discussions. And as Ian mentioned in his prepared remarks, unfortunately, the exact timing of when those are going to conclude is uncertain just because they’re not directly within our control. [Source: Vertex’s Q2/2017 Conference Call]
Lastly, Vertex’s management was upbeat about the clinical profile showed by their triple combo in both het/min population and a homozygotes population. As a reminder, few weeks ago, Vertex has published very strong data from Phase I and II for three different triple combos. As reported in their press release:
Data from the Phase 2 studies in these patients showed mean absolute improvements in percent predicted forced expiratory volume in one second (ppFEV1) of 9.7 and 12.0 percentage points from baseline for the triple combination regimens with VX-152 (200mg q12h) or VX-440 (600mg q12h), respectively. Initial data from a Phase 1 study showed a mean absolute improvement in ppFEV1 of 9.6 percentage points from baseline for the triple combination regimen of VX-659, tezacaftor and ivacaftor in people with one F508del mutation and one minimal function mutation. The company also announced today initial data showing improvements in mean absolute ppFEV1 of 7.3 and 9.5 percentage points when VX-152 or VX-440 was added in people with two copies of the F508del mutation, who were already receiving tezacaftor and ivacaftor. The triple combination regimens were generally well tolerated across all three studies, and the majority of adverse events were mild to moderate in severity. Across the studies, the discontinuation rate due to adverse events was low.
Vertex’s management believes to be able to treat 90% of patients affected by cystic fibrosis thanks to the triple combo regimen. We should wait for H1/2018 for the next update about the triple combo and some more details about the Phase III study design for this intriguing asset.
I will show now why I believe Vertex’s stock price offers an attractive risk/reward into the next clinical readouts for the triple combo.
As showed in the following graph, Vertex is currently able to treat only 30.000 of 75.000 patients affected by cystic fibrosis thanks to Kalydeco and Orkambi, but thanks to the new drug regimens studied (double combo tez+iva and triple combo), they should be able to treat at least 68.000 patients.
Source: Vertex’s Q2 2017 Results Presentation
Thus, I have done few scenario analysis to assess how much should be valued Vertex, according different assumptions related to the ability of the company to treat as much patients as they can.
In this scenario, I have assumed that Vertex will not be able to launch neither tez/iva nor the triple combo, so the company would be able to treat only 40% of the population affected by CF.
Source: My Own Valuation Model
Assuming that Vertex will achieve 90% of market share into this population, and applying 60% peak EBIT margin with 20% tax rate, I estimate a peak EPS of around $6. Assigning a long term average P/E of 15x, I estimate a fair value for Vertex shares of $90 or 40% downside from current level.
In this scenario, I have assumed that Vertex will be able to launch a new double regimen of tez+iva which offers two benefits compared to Kalydeco + Orkambi:
- It will allow to treat all the patients affected by Residual Function and Splicing Mutations, which are estimated to be about 5000 globally (while currently Kalydeco should be used only in 900 patients in US affected by Residual Function Mutation).
- The net pricing of tez+iva will be higher than Orkambi, because this combo compares favorably with Orkambi in terms of respiratory tolerability, so the patients will have higher compliance and persistence in use.
In addition to that, I have assumed that Vertex will be able to fully penetrate the F508del Homozygous Segment of Age 2-11, which could add around 10.000 additional patients.
Source: My Own Valuation Model
Assuming that Vertex will achieve 90% of market share into these populations, and applying 60% peak EBIT margin with 20% tax rate, I estimate a peak EPS of around $11. Assigning a long term average P/E of 15x, I estimate a fair value for Vertex shares of $161 or 4% upside from current level.
In this scenario, I have assumed that Vertex will be able to launch in the market the triple combo regimen, which will allow penetrating the last relevant segment of CF patients, called Het-Min population (around 25000 patients).
In addition to that, I have assumed that the majority of existing CF patients will switch to the triple combo, thanks to its higher efficacy.
Assuming that Vertex will achieve 90% of market share into these populations, and applying 60% peak EBIT margin with 20% tax rate, I estimate a peak EPS of around $17. Assigning a long term average P/E of 15x, I estimate a fair value for Vertex shares of $260 or 69% upside from current level.
In summary, assigning a 1% probability to Scenario 1, a 30% to Scenario 2 and 69% to Scenario 3 (which seems the most likely given the strong Phase II data for the Triple Combo), I believe that Vertex shares will still offer 50% of upside from the current stock price.
Source: My Own Valuation Model
The key investor takeaway is that the corporate signals have been excellent, with a solid performance of the existing growth driver and extraordinary results from the key assets in the pipeline. I was wrong, as discussed here, in assessing that risk/reward was not compelling in this name, but after the strong Phase II data for the triple combo, I’m looking for any sustained pullback in the name to build my position.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Not investment advice