Note to Reader: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report: 3Q09 Earnings Update
Prev. Ed.: October 14, 2009; Received EU Approval for Simponi
Brokers’ Recommendations: Neutral: 66.7% (6 firms); Positive: 33.3% (3); Negative: 0.0% (0) Prev. Ed.:6; 3; 0
Brokers’ Target Price: $30.25 (↑ $1.89 from the last edition; 6firms) Brokers’ Avg. Expected Return: 5.3%
Note:*Though dated October 29, share price and brokers’ materials are as of October 23.
Note: The tables below for Revenue, Margins, and Earnings per Share contain less brokers’ materials than the brokers’ materials used in the Valuation table. The extra figures in the Valuation table come from reports that did not have accompanying spreadsheet models.
Portfolio Manager Executive Summary
Schering-Plough (SGP) is a global healthcare company that offers both prescription and over-the-counter (OTC) products. The company specializes in anti-infective, anticancer, allergy/respiratory and cardiovascular products such as Temodar (brain cancer), Clarinex (allergy relief), Nasonex (allergy relief), Remicade (anti-inflammatory), and Zetia and Vytorin (cholesterol inhibitor). Besides, its prescription drug Claritin, used to treat allergies, is also available over the counter. In March 2009, Merck & Co. and Schering-Plough Corp. announced that they plan to merge in a deal worth more than $41 billion as part of an effort to create a pharmaceutical giant that is less dependent on US sales or on just a few blockbuster products.
33.3% of the firms providedpositive ratings on the stock while 66.7% maintained a neutraloutlook and nonerated the stock negatively. Two of the analysts did not provide any rating on the stock.
Neutral or equivalent outlook (6/9 firms): Target price of $29.00. These analysts believe that most of the growth will be driven only by the cost-cutting initiatives and the sales of Remicade and a number of smaller drugs such as Noxafil and Asmanex as well as Organon sales. However, SGP has a favorable growth outlook, lack of material generic risk, attractive pipeline assets, and operating leverage afforded by its Productivity Transformation Plan (PTP).
The firms with a neutral stance do not foresee significant impediments to a smooth closing of the SGP and Merck deal. However, JNJ could subsequently seek arbitration regarding ownership of the Remicade franchise, if the parties do not resolve the issue prior to closing.
Positive or equivalent outlook (3/9 firms): Target prices range from $29.00-$34.00. The bullish firms remain optimistic about the long term as SGP has limited patent risk through 2015. SGP’s R&D pipeline includes several promising compounds (TRA, Vicriviroc, and Boceprevir) that could fuel EPS growth in the coming years, if successful. Further, the analysts view Sugammadex(in Phase IIItrials for neuromuscular block reversal) as a potential blockbuster drug and believe its approval would provide additional product portfolio diversification and operating margin expansion.
The bullish analysts believe that the risk to the Merck and SGP deal and its timing is minimal.
Outlook: SGP and Merck deal makes strategic sense according to the analysts as the new company’s product portfolio is more diversified, with significant cost savings (approximately $3.5 billion synergies targeted beyond 2011). They also feel that SGP is the only company in the pharma universe that doesn’t face major patent expirations over the next 5 years. The lack of a material generic risk coupled with contributions from its pipeline products and operating leverage afforded by its $1.5 billion Productivity Transformation Program (PTP) should enable the company to have a growth rate above the peer group average. In 3Q09, SGP's PTP cost savings plan delivered $1billion in savings of the $1.5 billion expected by 2012.
October 29, 2009
Recent Events
On October 22, 2009, SGP announced its financial results for 3Q09. Highlights are as follows:
- Net sales for 3Q09 was $4.50 billion, versus $4.60 billion in 3Q08.
- Net income available to common shareholders was $477 million or $0.29 per common share in 3Q09 versus $576 million or $0.35 per common share in 3Q08.
On October 6, 2009, SGP and Centocor Ortho Biotech Inc. announced that the European Commission has approved Simponi (Golimumab) as a once-monthly, subcutaneous therapy for the treatment of moderate-to-severe, active rheumatoid arthritis (RA), active and progressive psoriatic arthritis (PsA) and severe, active ankylosing spondylitis (AS).
Overview
Schering-Plough Corporation (SGP or the company), based in Kenilworth, New Jersey, is engaged in the discovery, development, manufacturing, and marketing of pharmaceutical and health care products worldwide, including prescription drugs, animal health, over-the-counter products, foot care products, and sun care products. Through a joint venture, SGP and Merck co-developed and now co-market the cholesterol-lowering combination drug Zocor/Zetia called Vytorin. SGP is being acquired by its long-time cholesterol franchise partner, Merck & Co. MRK (announced in March 2009) and this deal is expected to close in 4Q09.
The company’s website is
Analysts identified the following factors for evaluating an investment in SPG:
Key Positive Arguments / Key Negative ArgumentsManagement’s strategy of forming alliances, acquiring products, and maintaining prudent cost control, are being positively viewed by the analysts. / SGP is heavily dependent on the cholesterol franchise, which is not doing very well.
SGP has a number of late-stage pipeline drugs that should start contributing in 4Q09. / The primary risk for SGP is the failure to complete the acquisition by Merck.
SGP is the only company in the pharma universe that doesn’t face major patent expirations over the next 5 years.
SGP has a favorable growth outlook, lack of material generic risk, attractive pipeline assets and operating leverage afforded by its Productivity Transformation Plan (PTP).
Note: SGP’s fiscal year coincides with the calendar year.
October 29, 2009
Revenue
According to the company, GAAP net sales in 3Q09 totaled $4.5 billion, down 2% y/y, reflecting operational growth of 4% and an unfavorable impact from foreign exchange of 6% during 3Q09. The Zacks Digest average total revenue was $4,499 million in 3Q09, a decrease of 1.7% y/y.
Provided below is a summary of total revenue as compiled by Zacks Digest:
Total Revenue ($M) / 3Q08A / 2008A / 1Q09A / 2Q09A / 3Q09A / 4Q09E / 2009E / 2010E / 2011EDigest Average / $4,576.0 / $18,506.5 / $4,393.2 / $4,647.0 / $4,499.0↑ / $4,455.0↓ / $17,977.8↑ / $18,829.8↓ / $19,710.8↓
Digest High / $4,576.0 / $18,560.0 / $4,394.0 / $4,647.0 / $4,499.0↑ / $4,604.0↑ / $18,144.0↓ / $19,494.0↓ / $20,866.0↑
Digest low / $4,576.0 / $18,502.0 / $4,393.0 / $4,647.0 / $4,499.0↑ / $4,196.0↓ / $17,735.0↑ / $17,735.0↓ / $18,020.0↓
Year over Year Growth / 62.7% / 46.0% / -5.7% / -5.6% / -1.7%↑ / 2.3%↓ / -2.9% / 4.7%↓ / 4.7%↑
Specific Products
Note: Recent significant changes have been highlighted in bold.
PRESCRIPTION PHARMACEUTICALS
Sales of Prescription Pharmaceuticals in 3Q09 totaled $3.5 billion, reflecting operational growth of 6% offset by a 6% unfavorable impact from foreign exchange.
Within the Pharmaceuticals Segment, the company reports revenue from the following drugs:
Claritin Family (Claritin and Clarinex (Desloratadine))
Indication: Claritin and Clarinex are used to treat allergies, hives (urticaria), and other allergic inflammatory conditions. Both Claritin and Clarinexare antihistamines. Antihistamines prevent sneezing, runny nose, itching and watering of eyes, and other allergic symptoms (both indoor and outdoor allergies).
Product Life Cycle Position: Fully commercialized. Claritin is also available as a dry syrup in Japan for patients aged 3 years and older. Additionally, Claritin tablets and Claritin (loratadine) Reditab tablets have been approved for patients over 7 years. SGP also introduced a new Claritin Liqui-Gels in January 2009 for adults and children aged 6 years and older, the first and only non-drowsy allergy medicine in an easy-to-swallow liquid filled capsule.
On September 1, 2009, SGP announced the introduction of Claritin12-Hour, the only 12-hour allergy medicine found in the allergy aisle. The product is available for adults and children aged six and above.
Sales: According to the company, global sales of Clarinex were $164 million, a decrease of 7% y/y. Sales of prescription Claritin were $95 million, a 9% increase y/y. According to the Zacks Digest model, sales of the Claritin family were $259.0 million in 3Q09, a decrease of 1.5% y/y.
Litigation: SGP announced an agreement with Orchid Chemicals & Pharmaceuticals Ltd. and Orgenus Pharma, Inc. (Orchid), related to the generic manufacturing of certain formulations of Clarinex on August 11, 2009. The agreement resolves all pending patent infringement litigation filed by SGP against Orchid and will allow Orchid to introduce a generic version of the Clarinex brand Reditabs (orally-disintegrating tablets) inthe US market on January 1, 2012 and Clarinex brand 5 milligram tablets on July 1, 2012. Schering holds various patents related to Clarinex that will extend to 2022.
A generics company GeoPharma Inc., settled a patent suit with SGP and Sepracor Inc. (now a part of Dainippon Sumitomo Pharma) relating to its generic version of Clarinex in January 2009. Under the settlement, GeoPharma can commercially launch its generic product, with 6 months marketing co-exclusivity, on July 1, 2012, or earlier in certain circumstances. The new product launch may be a prescription or over-the-counter product depending on its status at the time of launch.
Mylan Inc. settled a patent lawsuit in April 2009, brought by SGP and will be able to start selling a generic version of the allergy drug Clarinex on July 1, 2012. Under the agreement, Mylan will be allowed to market 5 mg tablets of desloratadine, the active ingredient in the drug, providing its version receives approval from the FDA. The companies settled all outstanding patient litigation, which dated back to September 2006.
$ in Million / 2008A / 2009E / 2010E / 2011E / Est. GrowthClaritin Family / $1,214.2 / $1,130.0↑ / $987.5↓ / $921.5↓ / -8.8%↓
Vytorin and Zetia (Cholesterol Franchise)
Indication: Vytorin is the cholesterol fighting combination of SGP’s Zetia (ezetimibe) and MRK’s Zocor (simvastatin). Zetia is an anti-hyperlipidemic medication, which is used to lower cholesterol levels. It acts by decreasing cholesterol absorption in the intestine.
Product Life Cycle Position: Mature and widely sold
Safety Issues: The US health officials warned the public on August 8, 2008, about the risk of a rare type of muscle injury seen when the cholesterol-drug simvastatin is combined with the anti-arrhythmia medicine Amiodarone. Simvastin is one of the two components in Vyotrin.
Partners: The Vytorin-Zetia franchise is a 50:50 joint venture with Merck. SGP and Bayer have launched Zetia in Japan. SGP will split Japanese Zetia revenue with Bayer.
Sales: According to the company, net sales of the cholesterol franchise, which include sales of the cholesterol joint venture(Vytorin and Zetia), plus sales recorded by SGP in non-joint venture territories (such as Japan and Latin America), declined 5% in 3Q09 to $1.1 billion, reflecting a 2% operational decrease and a 3% unfavorable impact from foreign exchange. Sales declined 10% in the US. In international markets, sales increased 3%, reflecting operational growth of 10% and a 7% unfavorable impact from foreign exchange. Zetia in Japan, contributed $47 million to cholesterol franchise sales in 3Q09. According to the Zacks Digest model, cholesterol franchise sales in3Q09 was $1050.6 million, a decrease of 1.8% y/y.
Additional Studies: SGP and Merck are conducting a larger trial called IMPROVE-IT. Ithas 15,000 of 18,000 patients enrolled with results expected in 2012, which is expected to answer many of the questions raised by ENHANCE. The trial had initially expected to enroll 12,500 patients with data expected in 2011, but was increased in size and duration in March 2008 at the recommendation of the study’s academic leaders.
Results of the ARBITER-6 cIMT study (Zetia versus Niaspan) that was terminated will be presented at the AHA meeting on November 16, 2009.
Litigations: SGP and Merck announced on August 5, 2009, that they have agreed to resolve a pending class action suit over Vytorin and Zetia for $41.5 million. The settlement will resolve all civil class action suits that seek compensation related to purchase of the drugs. The companies added that the settlement is not an admission of misconduct or liability in association with the products.
SGP and Merck & Co. in July 2009, agreed to pay $5.4 million in legal costs incurred by 35 states and the District of Columbia regarding their probe of how Vytorin and Zetia were marketed. The settlement agreement does not require the companies to make any other payment, and does not require or include any admission of misconduct or liability by the companies.
$ in Million / 2008A / 2009E / 2010E / 2011E / Est. GrowthCholesterol Franchise (MRK-SGP JV) / $4,331.6 / $4,094.5↑ / $4,048.0 ↑ / $4,118.0↑ / -1.7%↑
Remicade
Indication: Rheumatoid arthritis (RA),Crohn’s disease, pediatric Crohn's disease ankylosing spondylitis, psoriatic arthritis, psoriasis, and moderate-to-severe ulcerative colitis.
Product Life Cycle Position: Currently available in Europe.
Importance: It isa key international growth driver of revenue and continues to perform well.
Safety Issues: People with heart failure should not take Remicade. However, there are reports of serious infections, including tuberculosis (TB), sepsis, and pneumonia. Some of these infections have been fatal.
The FDA warned on August 4, 2009, that several of the leading biologic medications used to treat rheumatoid arthritis like Remicade and Simponi, can increase the risk of cancer when used in children and adolescents. The medications will now carry a boxed warning advising ofa cancer risk.
Partners: SGP and Centocor, Inc. (a subsidiary of JNJ) revised their 1998 distribution agreement for the development, commercialization, and distribution of both Remicade and its pipeline drug Golimumab. Effective upon the regulatory approval of Golimumab in the EU, SGP’s marketing rights to both the products will be extended for 15 years after Golimumab’sfirst commercial sale. In addition, Centocor will receive a progressively increased share of profits on SGP’s distribution of both products in the SGP marketing territory between 2010 and 2014, and remain fixed thereafter for the remainder of the term.
Johnson &Johnson (JNJ) filed an arbitration demand on May 27, 2009, that seeks to end its Remicade drug partnership with SGP. The arbitration claims that the planned merger between SGP and Merck triggers the termination of the agreements between SGP and Centocor Ortho Biotech Inc. regarding Remicade and Simponi.
Sales: According to the company, sales of Remicade increased 8% y/y to $608 million in 3Q09 primarily due to continued market growth. The Zacks Digest average figure was in-line with the company’s reports.
Competitors: Remicade’s growth prospects appear solid, although competition from Enbrel (AMGN) and Humira (ABT) is heating up.
Additional Indications: Future growth for Remicade will be driven by its approval for indications in psoriatic arthritis, ulcerative colitis (Phase III, fast track status received), and psoriasis (Phase III). Remicade is also under development for other indications (early RA and juvenile RA). JNJ and SGP are working to expand awareness about the use of Remicade with the ATTRACT and ASPIRE trials, which have demonstrated an improvement in the physical function of patients (with moderate to severely active RA) on Remicade therapy.
$ in Million / 2008A / 2009E / 2010E / 2011E / Est. GrowthRemicade Sales / $2,118.8 / $2,313.5↑ / $2,559.5 ↑ / $2,768.0 ↑ / 9.3%↑
Hepatitis C Franchise (PEG-Intron, Intron A, and Rebetol)
Indication: PEG-Intron is indicated to be used alone or in combination with Rebetol capsules for the treatment of chronic hepatitis C virus (HCV) in patientsof at least 18 years of age with compensated liver disease, who have not been previously treated with interferon alpha. The combination is also approved by the FDA for use in previously-untreated patients aged 3 years and older with chronic hepatitis Cand compensated liver disease. SGP received the EU approval for using PEG-Intron plus Rebetol for the treatment of previously-untreated hepatitis C patients, who are also infected with HIV.
Intron A (interferon alfa-2b, recombinant) for injection in conjunction with anthracycline-containing combination chemotherapy has been approved for the initial treatment of patients with clinically aggressive non-Hodgkin's lymphoma (NHL). It is also indicated for the treatment of chronic hepatitis B, chronic hepatitis C, hairy cell leukemia, AIDS related Kaposi's sarcoma, condylomata acuminata (venereal warts), and as adjuvant therapy for malignant melanoma.
Product Life Cycle Position: PEG-Intron and Rebetolare the main drugs under the HCV franchise of SGP. Both are mature, widely sold, and distributed.
Safety issues: FDA staff reviewers stated on October 1, 2009, that PEG-Introncarries substantial toxicity and had no effect on overall survival in melanoma skin cancer patients undergoing surgery.
In a separate document, SGPstated that the drug increased the time before the cancer reoccurredwith patients, who were only observed experiencing a relapse of25.5 months compared with 34.8 months with PEG-Intron.
Importance: The HCV franchise is the key driver of revenue. However, in the face of tough competition, revenue is expected to decline over the next few years.
PEG-Intron remains No. 1 in Japan due to its very strong ramp. Moreover, the approval of Peg-Intron (Peg-Interferon alfa-2b) and Rebetol (ribavirin, USP) combination therapy for their use in previously-untreated patients aged 3 years and older with chronic hepatitis C is the first and only approval for pediatric hepatitis C. PEGIntron/Rebetol is the only pegylated interferon combination therapy approved in the US for treatment experienced HCV patients.
Regulatory Issues: On October 30, 2009, SGP announced FDA issued a complete response letter to the company's supplemental Biologics License Application regarding PEG-Intronfor the adjuvant treatment of patients with stage III malignant melanoma after complete lymphadenectomy. SGP will work closely with FDA to respond to outstanding concerns related to the Peg-Intron melanoma filing.
SGP announced on October 5, 2009, that the FDA’s Oncologic Drugs Advisory Committee (ODAC) recommended approval by a vote of six to four for PEG-Intron in the adjuvant treatment of patients with Stage III malignant melanoma. SGP is seeking FDA permission to sell the drug for use in patients, whose melanoma has spread to the lymph nodes and who would undergo surgery to remove both the cancer and the surrounding lymph nodes. It is already approved to treat liver disease.
Sales: According to the company, sales of PEG-Intron decreased 16% y/y to $198 million in 3Q09 with lower sales in both the US and outside the US. According to the Zacks Digest model, hepatitis C franchisesales were $295.6 million in 3Q09, a decrease of 17.7% y/y. The decline in demand is attributable to a number of factors including the use of shorter courses of therapy in certain patient types, a significant recent expansion of the clinical trial population for trials testing new approaches for HCV therapy in combination with interferons, and greater competitive pressures. International growth is also slowing for these reasons.