Leading Independent Investment Research, Morningstar, Inc.

Morningstar

Leading Independent Investment Research

Morningstar, Inc.

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Thematic (Sector/Industry)

<div class="content-highlight"><h2>The potential for Merck and Roche looks underappreciated.</h2></div><hr>Innovation in immuno-oncology drugs has supported the moats for <a href="https://www.smartkarma.com/entities/merck-co-inc" target="_blank" data-smartkarma-citation="entities:1130:1">Merck &amp; Co Inc. (MRK US)</a>, <a href="https://www.smartkarma.com/entities/roche-holding-ltd" target="_blank" data-smartkarma-citation="entities:976:1">Roche Holding Ltd (ROG VX)</a>, <a href="https://www.smartkarma.com/entities/bristol-myers-squibb-co" target="_blank" data-smartkarma-citation="entities:1133:1">Bristol Myers Squibb Co (BMY US)</a>, and <a href="https://www.smartkarma.com/entities/astrazeneca-plc" target="_blank" data-smartkarma-citation="entities:21824:1">AstraZeneca PLC (AZN LN)</a>, and we expect expansion into the adjuvant/neoadjuvant settings to strengthen these moats. We project the lung adjuvant/neoadjuvant market to expand the potential by close to $10 billion in annual sales (not probability-weighted) by 2027, adding to almost $40 billion projected in the latestage metastatic settings. We estimate an 85% probability of success in this early-treatment setting based on early clinical data and the strength of the drugs in the late-stage setting. We view Merck and Roche as best positioned in the adjuvant setting due to a first-mover advantage with upcoming clinical data in 2020-21. While Bristol and Astra have earlier data in 2020 in the neoadjuvant setting, we are skeptical that these neoadjuvant studies without combination adjuvant chemotherapy will show strong enough efficacy to be competitive. Overall, including both early- and late-stage settings, we believe the potential of immuno-oncology drug sales is most underappreciated for Merck and Roche, and we see both of these companies as undervalued.<hr><h2>Key Points</h2><ul>
<li>Merck's and Roche's potential in immuno-oncology looks underappreciated versus consensus expectations, and the addition of the adjuvant lung potential strengthens the firms' positioning.</li>
<li>We estimate the lung neoadjuvant/adjuvant market share for Merck (35%), Roche (35%), AstraZeneca (15%), and Bristol-Myers (15%) based on timing and design of clinical studies, early-stage study results, and data in the metastatic disease setting.</li>
<li>Successful studies in neoadjuvant lung, nonresectable stage III lung (early but not as early as neoadjuvant and adjuvant), and adjuvant melanoma support an 85% probability of adding neoadjuvant and adjuvant lung cancer indications to the leading PD-1/PD-L1 drugs.</li>
<li>Data at ASCO 2019 strengthens the outlook for neoadjuvant/adjuvant treatment with a PD-1/PD-L1 drug, with Bristol's combination of Yervoy and Opdivo showing a stronger major pathological response rate (33%) than the historical trend seen with chemotherapy (27%) in the neoadjuvant setting.</li>
</ul>

The potential for Merck and Roche looks underappreciated.Innovation in immuno-oncology drugs has supported the moats for Merck &amp; Co Inc. (MRK US), Roche Holding Ltd (ROG VX), Bristol Myers Squibb Co (BMY US), and AstraZeneca PLC (AZN LN), and we expect expansion into the adjuvant/neoadjuvant settings to strengthen these moats. We project the lung adjuvant/neoadjuvant market to expand the potential by close to $10 billion in annual sales (not probability-weighted) by 2027, adding to almost $40 billion projected in the latestage metastatic settings. We estimate an 85% probability of success in this early-treatment setting based on early clinical data and the strength of the drugs in the late-stage setting. We view Merck and Roche as best positioned in the adjuvant setting due to a first-mover advantage with upcoming clinical data in 2020-21. While Bristol and Astra have earlier data in 2020 in the neoadjuvant setting, we are skeptical that these neoadjuvant studies without combination adjuvant chemotherapy will show strong enough efficacy to be competitive. Overall, including both early- and late-stage settings, we believe the potential of immuno-oncology drug sales is most underappreciated for Merck and Roche, and we see both of these companies as undervalued.Key Points
Merck's and Roche's potential in immuno-oncology looks underappreciated versus consensus expectations, and the addition of the adjuvant lung potential strengthens the firms' positioning.
We estimate the lung neoadjuvant/adjuvant market share for Merck (35%), Roche (35%), AstraZeneca (15%), and Bristol-Myers (15%) based on timing and design of clinical studies, early-stage study results, and data in the metastatic disease setting.
Successful studies in neoadjuvant lung, nonresectable stage III lung (early but not as early as neoadjuvant and adjuvant), and adjuvant melanoma support an 85% probability of adding neoadjuvant and adjuvant lung cancer indications to the leading PD-1/PD-L1 drugs.
Data at ASCO 2019 strengthens the outlook for neoadjuvant/adjuvant treatment with a PD-1/PD-L1 drug, with Bristol's combination of Yervoy and Opdivo showing a stronger major pathological response rate (33%) than the historical trend seen with chemotherapy (27%) in the neoadjuvant setting.


Immuno-Oncology Drugs in Adjuvant Lung: The Next Frontier in Strengthening Moats

'Quantamental' Japan Specialist, LightStream Research

Campbell Gunn

'Quantamental' Japan Specialist

ja research

ja research is an independent research platform focused exclusively on Japanese equities. Leveraging data and graphic analysis provided by Japan Analytics, we provide insights on small and medium-sized companies that have been ignored by the sell-side as well as challenging conventional wisdom on larger companies. We also offer analyst and corporate access, the latter with translation if required. 

Quantitative Analysis

<div class="content-caption">
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/080/728/original/2019-03-02_20-40-55.png?1551526871" class="editor-image img-responsive" data-smartkarma-image-id="80728"></figure>Source: Japan Analytics
</div>LIQUIDITY RULES - Despite the continuous stream of negative macroeconomic news from Japan and other economies, financial liquidity trends are the strongest in over two years, and much of this 'boom' is flowing into risk assets. Large-scale repatriation of offshore funds by US companies has also helped boost the US dollar against the yen. The Market Composite responded by rising 2.3% over the last two weeks, although only by 1% in US dollar terms.WEAK MACRO - Net exports and higher inventories offset private investment and consumption during the fourth quarter, resulting in flat GDP growth year-on-year. January industrial production fell to the lowest level in 30 months, and, with the manufacturing PMI nearing 50, the prospect is for further weakness this quarter. Inventories continue to rise and, in North Asia, to levels last seen in 2005. Combined with the sharp fall in exports in Japan, Korea and Taiwan, export pricing in back in deflationary territory, putting further upward pressure on real interest rates.  Meanwhile, January retail sales saw the largest month-on-month decline in over three years as department stores saw fewer Chinese tourists over the New Year.  Equity markets are living on 'borrowed time'.  <figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/080/722/original/2019-03-02_18-02-59.png?1551517390" class="editor-image img-responsive" data-smartkarma-image-id="80722"></figure><figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/080/724/original/2019-03-02_18-07-56.png?1551517689" class="editor-image img-responsive" data-smartkarma-image-id="80724"></figure><figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/080/729/original/2019-03-02_20-41-51.png?1551526925" class="editor-image img-responsive" data-smartkarma-image-id="80729"></figure><div class="content-caption">Source: Japan Analytics</div>HOLD FOR NOW - This bear market rally is two months old and is maturing. The Value Traded ratio is below trend again, the RSI is neutral, and the Toraku is signalling caution. We expect another month of liquidity/weak Yen-driven strength before the economic realities begin to prevail.MARKET/SECTOR STRATEGY- We continue to recommend an underweight position in Japan in global portfolios and favour undervalued domestically-orientated companies in the Information Technology, Internet, Media, Transportation, Healthcare and Telecommunications sectors. We would avoid or short the financial sectors Banks, Non-Bank Finance and Multi-Industry. We would underweight the Auto, Retail and Other Consumer Products sectors as consumer spending contracts further in the US, Europe, China and Japan. In the DETAIL section below, we will review Sector performance, company results, revisions and stock performance over the previous two weeks, as well as adding some brief comments on <a href="https://www.smartkarma.com/entities/10020" target="_blank" data-smartkarma-citation="entities:10020:1">Sakai Moving Service (9039 JP)</a>, <a href="https://www.smartkarma.com/entities/20269" target="_blank" data-smartkarma-citation="entities:20269:1">Sumitomo Chemical (4005 JP)</a>, <a href="https://www.smartkarma.com/entities/8431" target="_blank" data-smartkarma-citation="entities:8431:1">Parco (8251 JP)</a>, <a href="https://www.smartkarma.com/entities/4489" target="_blank" data-smartkarma-citation="entities:4489:1">Chugai Pharmaceutical (4519 JP)</a>, <a href="https://www.smartkarma.com/entities/14674" target="_blank" data-smartkarma-citation="entities:14674:1">Nichias (5393 JP)</a>, <a href="https://www.smartkarma.com/entities/27043" target="_blank" data-smartkarma-citation="entities:27043:1">Raksul (4384 JP)</a>, <a href="https://www.smartkarma.com/entities/10503" target="_blank" data-smartkarma-citation="entities:10503:1">Daito Trust (1878 JP)</a>, and <a href="https://www.smartkarma.com/entities/14502" target="_blank" data-smartkarma-citation="entities:14502:1">Benefit One (2412 JP)</a>.


Source: Japan Analytics
LIQUIDITY RULES - Despite the continuous stream of negative macroeconomic news from Japan and other economies, financial liquidity trends are the strongest in over two years, and much of this 'boom' is flowing into risk assets. Large-scale repatriation of offshore funds by US companies has also helped boost the US dollar against the yen. The Market Composite responded by rising 2.3% over the last two weeks, although only by 1% in US dollar terms.WEAK MACRO - Net exports and higher inventories offset private investment and consumption during the fourth quarter, resulting in flat GDP growth year-on-year. January industrial production fell to the lowest level in 30 months, and, with the manufacturing PMI nearing 50, the prospect is for further weakness this quarter. Inventories continue to rise and, in North Asia, to levels last seen in 2005. Combined with the sharp fall in exports in Japan, Korea and Taiwan, export pricing in back in deflationary territory, putting further upward pressure on real interest rates.  Meanwhile, January retail sales saw the largest month-on-month decline in over three years as department stores saw fewer Chinese tourists over the New Year.  Equity markets are living on 'borrowed time'.  Source: Japan AnalyticsHOLD FOR NOW - This bear market rally is two months old and is maturing. The Value Traded ratio is below trend again, the RSI is neutral, and the Toraku is signalling caution. We expect another month of liquidity/weak Yen-driven strength before the economic realities begin to prevail.MARKET/SECTOR STRATEGY- We continue to recommend an underweight position in Japan in global portfolios and favour undervalued domestically-orientated companies in the Information Technology, Internet, Media, Transportation, Healthcare and Telecommunications sectors. We would avoid or short the financial sectors Banks, Non-Bank Finance and Multi-Industry. We would underweight the Auto, Retail and Other Consumer Products sectors as consumer spending contracts further in the US, Europe, China and Japan. In the DETAIL section below, we will review Sector performance, company results, revisions and stock performance over the previous two weeks, as well as adding some brief comments on Sakai Moving Service (9039 JP), Sumitomo Chemical (4005 JP), Parco (8251 JP), Chugai Pharmaceutical (4519 JP), Nichias (5393 JP), Raksul (4384 JP), Daito Trust (1878 JP), and Benefit One (2412 JP).   

🇯🇵 Japan • Fortnightly Update - Liquidity Rules

The Best Ideas list is a compilation of stock ideas sourced from Morningstar’s global equity research team. With more than 100 analysts covering nearly 1,500 companies, we’re able to provide a wide variety of what we believe are attractively priced securities looking across sectors, industries, and geographies. Best Ideas are nominated by analysts and approved by managers in addition to the normal due diligence processes that precede our published research and ratings.The list may include a broad mix of quality and risk characteristics to meet varying investor needs, including no-, narrow-, and wide-moat companies as well as the full spectrum of uncertainty ratings from low to very high. Most or all of the highlighted stocks will be trading at a discount to our estimate of intrinsic value, indicating improved odds of capital appreciation.

The Best Ideas list is a compilation of stock ideas sourced from Morningstar’s global equity research team. With more than 100 analysts covering nearly 1,500 companies, we’re able to provide a wide variety of what we believe are attractively priced securities looking across sectors, industries, and geographies. Best Ideas are nominated by analysts and approved by managers in addition to the normal due diligence processes that precede our published research and ratings.The list may include a broad mix of quality and risk characteristics to meet varying investor needs, including no-, narrow-, and wide-moat companies as well as the full spectrum of uncertainty ratings from low to very high. Most or all of the highlighted stocks will be trading at a discount to our estimate of intrinsic value, indicating improved odds of capital appreciation.

IPOs and Catalysts/Events, Global Equity Research Ltd

Arun George

IPOs and Catalysts/Events

Uncompromised, Independent, Conflict-Free Research

Global Equity Research Ltd

Global Equity Research was started in 2017 by a group of experienced research professionals. It was founded on a passionate belief in the importance and the need for uncompromised, independent, conflict-free research. We aim to provide differentiated and actionable primary and bottom up fundamental research.

Equity Capital Markets

Hua Medicine Ltd / Equity Capital Markets

<a href="https://www.smartkarma.com/entities/27410" target="_blank" data-smartkarma-citation="entities:27410:1">Hua Medicine Ltd (2552 HK)</a> which specialises in developing drugs to treat Type 2 diabetes, is the third pre-profit biotech firm to IPO in Hong Kong since <a href="https://www.smartkarma.com/entities/27265" target="_blank" data-smartkarma-citation="entities:27265:1">Ascletis Pharma Inc (1672 HK)</a> and <a href="https://www.smartkarma.com/entities/27352" target="_blank" data-smartkarma-citation="entities:27352:1">BeiGene Ltd (6160 HK)</a>. In line with our recommendation to avoid the Ascletis IPO, the shares are down 34% post-IPO. In contrast, we are bullish on BeiGene and its shares are marginally down 2% post-IPO. The mid-point of Hua Medicine's IPO price range of HK$8.28-9.28 per share implies a market value of $1.2 billion (HK$9.2 billion).Hua Medicine has a Type 2 drug, Dorzagliatin, which is currently in Phase 3 trials and plans to submit a new drug application (NDA) in China by 2019. Hua Medicine claim to fame is that Dorzagliatin is the first ever GKA (glucokinase activator) globally to reach Phase 3 clinical trials. GKAs are designed to control the progressive degenerative nature of diabetes. Hua Medicine's innovative diabetes drug undoubtedly has huge potential due to the large addressable market in China driven by increasing treatment rates. However, we believe that IPO investors are being asked to participate at a valuation range that is unattractive due to:<ol>
<li>We value Hua Medicine on a risk-adjusted net present value (rNPV) basis. Hua Medicine’s founder, Dr Li Chen, was quoted in South China Morning Post that Hua Medicine is “targeting sales of about US$3 billion by 2025”, which would give Dorzagliatin a 15% share of China’s anti-diabetics market. Consequently, Hua Medicine’s valuation will be highly dependent on Dorzagliatin. Based on assumptions which we believe are bullish, we arrive at a rNPV valuation for Hua Medicine of $1.0 billion (HK$7.8 billion). This valuation is 11% below the low-end of the IPO valuation range.</li>
<li>
Dorzagliatin faces strong competition from established Type 2 diabetes therapies and from several companies pursuing new Type 2 diabetes therapies (including GKAs). Insulin had the largest share of the anti-diabetics market in China with a market share of 46% in 2017. Citing the US anti-diabetics market, Hua Medicine argues that new innovative drugs with good efficacy have made rapid gains in market share. However, we believe that the IPO price range already factors in this bullish scenario for Dorzagliatin in China.</li>
<li>The rNPV valuation is contingent on assumptions about the individual drug's peak market share and terminal EBIT margin. As shown below, the proposed IPO price range already factors in ambitious targets regarding these two metrics. For example, if Dorzagliatin's terminal EBIT margin is 40%, the peak market share for Dorzagliatin should be at least 15% to justify the IPO price range. Currently, in the China anti-diabetics market, α-glucosidase’s market share of 17% is the second largest after insulin. In other words, Dorzagliatin needs to establish itself as the leading anti-diabetics drug after insulin in China to justify the IPO price range.</li>
</ol><div class="content-caption">rNPV valuation sensitivity to terminal EBIT margin and peak market share</div><figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/062/492/original/Sensitivity.png?1535923539" class="editor-image img-responsive" data-smartkarma-image-id="62492"></figure><div class="content-caption">Source: Global Equity Research; Note: Grey highlighted area denotes valuation at or higher than the IPO valuation range, Red highlighted box denotes our valuation of Hua Medicine</div><div class="content-highlight">Our overall view is that while we do not doubt that Hua Medicine's drugs will be successful, the IPO valuation range already factors in bullish market traction for Dorzagliatin. Consequently, there is little money left on the table for IPO investors. While the relatively small IPO raise compared to Ascletis and BeiGene should help in quickly covering the books, we are inclined to sit on the sidelines.</div>

Hua Medicine Ltd (2552 HK) which specialises in developing drugs to treat Type 2 diabetes, is the third pre-profit biotech firm to IPO in Hong Kong since Ascletis Pharma Inc (1672 HK) and BeiGene Ltd (6160 HK). In line with our recommendation to avoid the Ascletis IPO, the shares are down 34% post-IPO. In contrast, we are bullish on BeiGene and its shares are marginally down 2% post-IPO. The mid-point of Hua Medicine's IPO price range of HK$8.28-9.28 per share implies a market value of $1.2 billion (HK$9.2 billion).Hua Medicine has a Type 2 drug, Dorzagliatin, which is currently in Phase 3 trials and plans to submit a new drug application (NDA) in China by 2019. Hua Medicine claim to fame is that Dorzagliatin is the first ever GKA (glucokinase activator) globally to reach Phase 3 clinical trials. GKAs are designed to control the progressive degenerative nature of diabetes. Hua Medicine's innovative diabetes drug undoubtedly has huge potential due to the large addressable market in China driven by increasing treatment rates. However, we believe that IPO investors are being asked to participate at a valuation range that is unattractive due to:
We value Hua Medicine on a risk-adjusted net present value (rNPV) basis. Hua Medicine’s founder, Dr Li Chen, was quoted in South China Morning Post that Hua Medicine is “targeting sales of about US$3 billion by 2025”, which would give Dorzagliatin a 15% share of China’s anti-diabetics market. Consequently, Hua Medicine’s valuation will be highly dependent on Dorzagliatin. Based on assumptions which we believe are bullish, we arrive at a rNPV valuation for Hua Medicine of $1.0 billion (HK$7.8 billion). This valuation is 11% below the low-end of the IPO valuation range.

Dorzagliatin faces strong competition from established Type 2 diabetes therapies and from several companies pursuing new Type 2 diabetes therapies (including GKAs). Insulin had the largest share of the anti-diabetics market in China with a market share of 46% in 2017. Citing the US anti-diabetics market, Hua Medicine argues that new innovative drugs with good efficacy have made rapid gains in market share. However, we believe that the IPO price range already factors in this bullish scenario for Dorzagliatin in China.
The rNPV valuation is contingent on assumptions about the individual drug's peak market share and terminal EBIT margin. As shown below, the proposed IPO price range already factors in ambitious targets regarding these two metrics. For example, if Dorzagliatin's terminal EBIT margin is 40%, the peak market share for Dorzagliatin should be at least 15% to justify the IPO price range. Currently, in the China anti-diabetics market, α-glucosidase’s market share of 17% is the second largest after insulin. In other words, Dorzagliatin needs to establish itself as the leading anti-diabetics drug after insulin in China to justify the IPO price range.
rNPV valuation sensitivity to terminal EBIT margin and peak market shareSource: Global Equity Research; Note: Grey highlighted area denotes valuation at or higher than the IPO valuation range, Red highlighted box denotes our valuation of Hua MedicineOur overall view is that while we do not doubt that Hua Medicine's drugs will be successful, the IPO valuation range already factors in bullish market traction for Dorzagliatin. Consequently, there is little money left on the table for IPO investors. While the relatively small IPO raise compared to Ascletis and BeiGene should help in quickly covering the books, we are inclined to sit on the sidelines.

Hua Medicine IPO Preview: Suffering from the Ascletis Over-Valuation Syndrome

Japan TMT Analyst

Pelham Smithers

Market Intel on Asian Tech with a Japan focus

Pelham Smithers Associates

Founded in 2009, Pelham Smithers Associates (PSA) provides market intelligence on Asian technology, focusing in particular on Japan. The industries covered by our team of specialists are: consumer electronics, telecomms, pharmaceuticals, internet, electronic parts and materials, automotive technology, retail and capital goods. 

Research is provided by the following:
Pelham Smithers: Macro, consumer electronics, telecoms & pharma
Joel Scheiman: Electronics materials / components
Julie Boote: Autos
Will Nestuk: Capital goods, machinery & transportation equipment parts
Thao Nguyen: eCommerce, internet content, marketing & advertising

Generally speaking, if Stanley Druckenmiller says something is a bad thing and Donald Trump suggests it is a good thing, or at least is an idea worth considering, there's a tendency to think that it is a suboptimal suggestion (and probably nine times out of ten it is). However, the suggestion that listed companies in the US should move to semi-annual reporting to save money and encourage longer-term investing is worthy of more than a quip that the President should try semi-annual tweeting (not…

Generally speaking, if Stanley Druckenmiller says something is a bad thing and Donald Trump suggests it is a good thing, or at least is an idea worth considering, there's a tendency to think that it is a suboptimal suggestion (and probably nine times out of ten it is). However, the suggestion that listed companies in the US should move to semi-annual reporting to save money and encourage longer-term investing is worthy of more than a quip that the President should try semi-annual tweeting (not…

Switzerland

Roche Holding AG develops and manufactures pharmaceutical and diagnostic products.  The Company produces prescription drugs in the areas of cardiovascular, infectious, autoimmune, and respiratory diseases, dermatology, metabolic disorders, oncology, transplantation, and the central nervous system.

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Roche Holding Ltd (ROG VX)

Immuno-Oncology Drugs in Adjuvant Lung: The Next Frontier in Strengthening Moats

The potential for Merck and Roche looks underappreciated.Innovation in immuno-oncology drugs has supported the moats for Merck & Co Inc. (MRK...

Morningstar, Inc.

🇯🇵 Japan • Fortnightly Update - Liquidity Rules

LIQUIDITY RULES - Despite the continuous stream of negative macroeconomic news from Japan and other economies, financial liquidity trends are the...

Campbell Gunn

Best Ideas List for January 2019

The Best Ideas list is a compilation of stock ideas sourced from Morningstar’s global equity research team. With more than 100 analysts covering...

Morningstar, Inc.

Hua Medicine IPO Preview: Suffering from the Ascletis Over-Valuation Syndrome

Hua Medicine Ltd (2552 HK) which specialises in developing drugs to treat Type 2 diabetes, is the third pre-profit biotech firm to IPO in Hong Kong...

Arun George

The Case for Semi-Annual Reporting

Generally speaking, if Stanley Druckenmiller says something is a bad thing and Donald Trump suggests it is a good thing, or at least is an idea...

Pelham Smithers Associates

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