In pharmaceutical industry, there are not that many innovation powerhouses – it really is very difficult to develop an innovative drug that can have uses for multiple diseases.
Innovation powerhouse is particularly rare outside of the United States in pharmaceutical industry and therefore they are often highly valued in their respective local markets for that reason – they are “safe to own” pharma names for fund managers in local markets.
Local institutional investors that want exposure to biotech / pharmaceutical sector simply buy these “local innovation powerhouses” to get exposure because their mandates often may not allow owning shares in US stock markets – home of US pharma / biotech companies that collectively monopolize on pharmaceutical innovation of the world.
Chugai is one of those rare pharmaceutical companies that have pioneered biotech industry through development of innovative therapies that have gone on to become blockbusters, which are Actemra and Hemlibra
Actemra and Chugai are special to the profitability and growth profile of Chugai because they are in-house developed products. What that means is that Chugai not only sells the products in Japan (as a subsidiary of Roche group, Chugai serves as a distributor of Roche’s global products in Japan) but also generates export and royalty revenues from Roche.
As shown below, Actemra and Chugai are expected to be critical revenue growth drivers for Chugai in FY2022. Ronapreve is the leading growth driver in 2022 through Japanese government contract.
However, if we look at operating profit growth, we will see that operating growth is essentially flat – this portends highly concerning future for Chugai –
Operating profit bridge indicates that Chugai operating profit is posed for annual declines post-2022 for following reasons:
FIRST – SAVED BY RONAPREVE ORDER: Without Ronapreve revenue – which is a one time big order benefit as it is Japanese government covid19 contract and the drug is proved to have no efficacy against Omicron, the operating profit could have been at least ~JPY 50BN (assuming 25% margin of JPY 200BN forecast revenue) below the current forecast. Therefore, FY2022 operating profit would have been closer to JPY 390BN – implying -10% operating profit decline.
SECOND – ACTEMRA BIOSIMILAR EROSION IN 2023: As one of the most successful therapies and one of the therapies that enjoyed one-time benefit as covid19 therapeutics, it has been a strong earnings growth driver, but its time is coming to an end in 2023. Multiple biosimilars are in development to eat away Actemra’s lunch. This means Chugai will lose not only domestic Actemra revenue, but also export revenue and rich royalty revenue that it receives from Roche. It is high contribution margin product – illustratively, if the revenue declines by -20% Y/Y, operating profit should decline by -25% or -30% Y/Y.
THIRD – HEMLIBRA IS STILL GROWING, BUT REVENUE QUALITY IS SIGNIFICANTLY DECLINING THROUGH CONTRACT. Chugai operating margin has been significantly benefiting as Roche has been paying high margin royalty for the first few years of launch, but contractually, Roche is no longer paying that high initial royalty, but is now paying export revenue. Royalty is 100% profit, but export revenue is much much lower profit.
In the chart below, blue is export revenue and gray is rich royalty revenue. Gray (high margin royalty revenue) has been fading out and blue (low margin export revenue) will have been almost 100% of revenue by the end of 2022. Most importantly, 2022 Hemlibra revenue will decline from 2021! We are seeing revenue erosion and significant contribution margin compression at the same time.
Ronapreve, Actemra, and Hemlibra issues would not be a problem for the stock if Chugai has strong in-house late stage pipeline asset – unfortunately… it does not.
Chugai wants investors to think crovalimab or Enspryng could become a significant product – unfortunately, Roche management do not really talk about them.. which means those products probably aren’t getting much support from Roche management team – who are the ultimate decision makers and are in better position to assess global commercial prospect.
So what does the future hold for Chugai?
Before Chugai stock started running up on Hemlibra, Chugai stock was trading around JPY 2,500 vs. current price of JPY 3,903. Chugai appears to be a company on its way back to pre-Hemlibra days in terms of strategic value – potentially even worse because investors had the near-term blockbuster Hemlibra in pipeline that Roche management was highly bullish on publicly. also, we now operate on a rising interest rate environment.
Could it go back <JPY 3,000? Only time will tell.
*not investment advice.
