Health Care/Biotech: A Good Prognosis

Roche’s first-half group core operating profit was clearly ahead of consensus, but only marginally ahead of Societe Generale’s, driven by strong pharmaceutical margins. Consensus was for a pharmaceutical core operating profit of 7,174 million Swiss francs for a 41.8 percent margin, and Societe Generale’s [outlook was for] 7,130 million Swiss francs for a 41 percent margin; Roche reported 7,385 million Swiss francs for a 43.9 percent margin.

We maintain our 2011 core EPS forecast of 13.40 Swiss francs, up 14.5 percent in [local-currency] terms, but see scope for consensus (currently 12.91 Swiss francs) to rise.

John Boris
Citi Investment Research
212-816-1635
[email protected]

Watson Pharmaceuticals Inc. (WPI) beat consensus on both the top and bottom line, with the magnitude of the raise $0.10 higher than we expected. WPI reported 2Q11 EPS of $1.01 (+22 percent), in line with our $1.01 and above the Street’s $1.00.

Total revenue of $1,082 million (+24 percent) beat our estimate by $88 million ($993 million) and the Street’s $994 million, driven by higher generic sales, partially offset by lower distribution revenues. Higher than projected sales (+$0.20), lower R&D (+$0.03) and lower than projected interest expense (+$0.04) were offset by lower gross margins (-$0.14), higher selling, general, and administrative expenses (-$0.12) and lower other income (-$0.01).

WPI raised its ’11 estimated EPS range by +$0.30 to $4.25(+24 percent) to $4.50 (+31 percent) from $3.95-$4.20 versus our $4.32 (+26 percent) and the Street’s $4.32. The high end of WPI’s range is above the $4.25-$4.40 we projected in our 2Q11 preview. We would take advantage of weakness in WPI’s shares and reiterate our Buy/$72 price target.

WPI acquired privately-held Specifar Pharma for $562 million in cash and $17.5 million in assumed debt in May, with an earn-out of up to 40 million euros tied to generic Nexium (esomeprazole) sales. The deal makes strategic and financial sense to us, with the price (ex-earn-out) representing about 4.9 times enterprise value/2010 sales of 80 million euros.

Strategically, Specifar provides WPI [with] a highly-profitable EU business that enhances its Arrow business, additional manufacturing and access to a significant generic, Nexium (a $1.2 billion brand value in Western Europe). WPI expects immediate accretion to ’11 non-GAAP EPS  and “substantially” accretive thereafter.

David Risinger
Morgan Stanley & Co. LLC
212-761-6494
[email protected]

We are raising our ’11 estimated revenue (for WPI) by 5 percent from $4.3 billion to $4.5 billion and raising ’11 estimated EPS by 3 percent from $4.34 to $4.45. Higher Concerta sales ($576 million versus our previous $442 million) are partially offset by slightly lower gross margins (estimated 35 percent versus our previous 37 percent).

Our ’11 estimate of $4.45 is 2 percent above the midpoint of management’s revised range of $4.25–$4.50 (midpoint: $4.38). We are also bumping ‘12–’13 estimates by 1 percent from $5.74–$5.80 and from $6.06–$6.10.