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Health Care: A Fit Forecast

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Karen Andersen, CFA
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The long patent life of Roche’s (RHHBY) portfolio puts it among the biotechs least exposed to generic competition. Patents don’t begin to expire until 2013 — when Rituxan loses protection in Europe — and management is implementing strategies to counteract future competitive pressures that we think will enable the firm to achieve 9 percent five-year earnings growth.

Subcutaneous versions of Roche’s blockbuster antibodies are in the works, which could reduce hospital costs and add to convenience. Novel drugs are in development that could improve on the efficacy of its current products or represent new, personalized treatments for cancer patients.

Roche also has a solid pipeline beyond oncology, including drugs to treat schizophrenia and hepatitis C. With the Genentech integration starting to yield synergies, we think Roche’s drug portfolio and industry-leading diagnostics conspire to create sustainable competitive advantages.

Overall, we continue to think Roche’s aggressive cost cutting, strong pipeline, and emerging market potential will provide a buffer from pressure due to Avastin in breast cancer, reform costs, and in the long run, bio-similar competition. Roche is also planning to expand its dividend by another 10 percent for 2010, boosting the already strong 4.2 percent dividend yield to 4.6 percent and providing another compelling reason to invest in this undervalued biotech.

John Boris
Citigroup Global Markets
[email protected]

Watson is a strong domestic generics company with high potential for international growth after the Arrow acquisition and with attractive specialty pharmaceuticals and distribution segments. With the acquisition of Eden Biodesign, Watson is also positioning itself to potentially build a position in biosimilars.

Currently, the majority of Watson’s sales are exposed to the generic segment that could materially benefit from manufacturing issues from other generic suppliers. Watson has a higher-margin branded segment that entered a new product cycle through the launch of Gelnique and Rapaflo in 2Q09. In addition, its higher growth distribution segment is the fourth largest distributor in the U.S. market.

We arrive at our $59 price target for Watson Pharmaceuticals (WPI) shares assuming the company trades at a forward price to equity (or P/E) multiple of  about 14.7 times our 2011 cash EPS estimate of $4.02, which is below WPI’s 10-year historical median (22 times) and average (23 times) forward P/E multiple.

Sean Lavin, M.D.
Lazard Capital Markets
[email protected]

Varian Medical Systems (VAR) is the world leader in radiation therapy and stereotactic surgery. A favorable product cycle and [outside-United States] adoption [should] propel growth over the next few years.

We believe that Varian offers superior technology, faster treatments, more versatility, and (often) lower-priced systems than its competitors. We recommend accumulating shares and believe that investors who do so will be rewarded over the next few years.

We expect 10-plus percent EPS growth this fiscal year, based largely on revenue that comes from orders [made] about a year ago during the worst of the economic slowdown. With this in mind, we are hard pressed to see how VAR isn’t a 15 percent-plus long-term earnings grower in a normal economy.

Management guided to 9-10 percent [year-over-year] revenue growth in 2Q11 and quarterly EPS of $0.83 to $0.86. For FY11, revenue is still expected to grow 10 to 11 percent, and EPS guidance was increased from between $3.34 and $3.39 to between $3.39 and $3.45.

This does not fully account for the 1Q EPS beat of $0.80, given previous guidance of $0.71 to $0.74, but management said it expects higher R&D spend[ing] in the rest of the fiscal year when compared with this quarter.