DB European Pharmaceuticals 2019 Outlook_watermark

Bank Deutsche

M&A: Innovate or die...more likely just buy

Mid range growth for the sector remains solid, thus large scale M&A remains unlikely for now

AG/London

■

EU Pharma is moderately levered despite moderate/large transactions by Bayer, GSK and Sanofi. The sector should generate a further $19bn in cash

(after dividends) in 2019 and acquisitions or further shareholder distributions are likely.

■

Market dynamics mean Biotechs justify high valuations. We expect large-cap pharma to focus on bolt on acquisitions in 2019, primarily given the

health of their earnings trajectory. However, the very real boom in innovation/science with a looser FDA regulatory environment is creating new

challenges. Biotechs have more value as timelines for development are quicker and costs to develop and launch are lower. This has twofold knock-on

to Big Pharma meaning they have to pay-up for acquisitions, and that they risk being too slow in competitive R&D categories. Furthermore, it means

faster obsolescence of existing products. As such, we expect continued bolt-on deals for new technologies and products by large pharma, which

utilises its scientists to identify targets before the street can. Longer term, we expect a bifurcation in strategies as less innovative companies become

consolidators of broad disease categories, rationalising costs vs a backdrop of price pressure in lower innovative categories.

■

Roche, Novartis most likely dealmakers. M&A is still likely at Novartis, as it seeks to rebuild its high-tech focus areas, coupled with divestment of

non-core (lower growth areas) such as the announced Alcon split as well as further divestments in generics and tail products. Roche typically makes

deals each year as a supplement to R&D. However, given biosimilar pressures and increased oncology competition in general, we do not rule out

larger diversifying acquisitions for this company. Novo Nordisk openly discusses potential deal-making in adjacent areas to diabetes. However, we

expect only small scale deals for this conservative company.

■

See Appendix A - M&A by company later in this report for our detailed company thoughts.

Figure 34 : Net debt positions in EU Pharma have increased following

Figure 35 : We expect EU Pharma to generate ~$19bn in FCF after

an acquisitive year

dividends in 2019

45

4.5

14

14%

40

Proforma including

4.0

Tesaro/Horlicks

12

12%

35

3.5

10

10%

)($DNBNEBTET

30

3.0

/EBITDADNEBTET

)($FCFBN

(%)IELDYFCF

8

8%

25

2.5

20

2.0

6

6%

15

1.5

4

4%

10

1.0

2

2%

5

0.5

0

0%

0

-

-2

-2%

-5

AZN

Bayer

GSK

Novartis

Novo

Roche

Sanofi

-0.5

AZN

Bayer

GSK

Novartis

Novo

Roche

Sanofi

Nordisk

Nordisk

2019 FCF ($bn)

FCF ($bn, after dividends)

FCF yield (rhs)

Net Debt end 2018 ($bn)

Average Net Debt/EBITDA

Net Debt/EBITDA

Page

Source: Deutsche Bank. Proceeds received by GSK's announced disposal of Horlicks business assumed as cash given the liquid

Source: Deutsche Bank

21

nature of the consideration received.

Page

Consumer Health: trends stabilising/improving;

22

consolidation still possible

Figure 36 : Consumer/OTC reported growth rates have stabilised but

Figure 37 : EU Pharma Consumer Health exposure

remain suboptimal

15.0%

Reckitt Cons H'care (CER, Organic)

30%

P&G Cons H'care (CER, Organic)

J&J Cons (CER. Organic)

sales

Pfizer Cons (CER)

Sanofi Cons (CER/Organic)

20%

10.0%

GSK Cons (CER)

group2018E

10%

Deutsche

5.0%

Bayer (CER/Organic)

% of

0%

0.0%

Astra

Bayer

GSK

Novartis

Novo

Roche

Sanofi

AG/LondonBank

-5.0%

Sector average

1Q15

2Q15

3Q15

4Q15

1Q16

2Q16

3Q16

4Q16

1Q17

2Q17

3Q17

4Q17

1Q18

2Q18

3Q18

Source: Company data

Source: Deutsche Bank

Page

AstraZeneca (Buy; PT 6,900p)

24

Figure 38: Bull/Bear case target price impact (GBp/share)

Figure 39: PE Company vs. EU Pharma – 1 yr FWD PE

8,500

1.6x

Rel. PE

311

7,528

10yr Ave

7,500

159

1.4x

+/- 1 s.d.

(GBp)price

6,900

159

276

fwd1yr(x),

6,314

242

69

1.2x

6,500

Share

tosector

1.0x

5,500

0.8x

PE rel.

Deutsche

4,500

ve-Lynparza

-Roxadustat ve

Roxadustat

+veLynparza

+ve IO

0.6x

Bear

veIO

Base

+ve

Bull

0.4x

0.2x

Jan 09

Aug 10

Apr 12

Dec 13

Aug 15

Apr 17

Dec 18

Bank

Source: Deutsche Bank estimates, * - current share price

Source: Deutsche Bank, Factset

AG/London

Deutsche

Focus for 2019

■

Margin leverage key to share price performance. Our forecasts suggest AZN will deliver ~$3bn of additional high margin sales from its new portfolio

Bank

in 2019. Our discussions with management have suggested that top-line growth will largely be allowed to drop to the bottom line going forward,

which should allow the company to guide to double digit EPS growth despite a headwind from likely lower overall externalisation and other operating

AG/London

inhibitor roxadustat confirm the drug's e cacy in treating anemia associated with kidney disease. Although safety needs to be confirmed, we believe

income. We expect margin expansion to improve thereafter reaching a 30% Group EBIT margin in 2020 and driving a 2018-22E EPS CAGR of ~18%.

■

Roxadustat readout could open multi-blockbuster opportunity. We see a high probability that upcoming Phase III trials of AZN's first-in-class HIF-PH

AZN sales could reach $1-3bn vs current consensus of ~$800m. This implies high single digit upside to '23E consensus EPS with ~3% downside.

Demonstration of superior cardiovascular outcomes in dialysis-dependent chronic kidney disease would secure the class as a new standard-of-care.

However, we believe the class could still have su cient di erentiation to ultimately justify blockbuster sales even without this data at the time of

launch.

■

IO portfolio and Lynparza still offer optionality; pipeline backfilling likely to gain momentum. Although the next 12 months will see the pace of key

pipeline data readouts at AZN slow, we continue to see optionalty from trials of Lynparzi in new potential indications, with results of the PAOLO-1 trial

(1L ovarian) and PROFOUND trials (prostate) potentially opening up >$2bn and ~$1bn market opportunities respectively. In addition, trials of Imfinzi/

tremelimumab in head and neck, bladder and small cell cancer and the POSEIDON trial in 1L NSCLC (+chemo) o er optionality given now very low

expectations. Finally, we expect AZN to begin to work to backfill its late stage pipeline with multiple mid stage assets potentially moving into Phase

III/pivotal trials including AKT inhibitor capivasertib (triple negative breast cancer) and monalizumab (head and neck/colorectal cancer).

Key news flow

Figure 40: Potential key news flow

Timing

Event

Description

4Q18

Roxadustat

Results from ROCKIES and OLYMPUS Phase III trials (AZN sponsored)

1Q19

Lynparza

PDUFA for 1L BRCAm ovarian cancer

1H19

Imfinzi/tremelimumab

Results KESTREL Phase III trial in SCCHN (1L)

1H19

Roxadustat

Pooled CV safety data

1H19

Roxadustat

Planned FDA filing

1H19

Lynparza

Results of Phase III POLO trial in BRCAm pancreatic cancer

1H19

Imfinzi/tremelimumab

Results of NEPTUNE Phase III trial in 1L NSCLC (survival)

1H19

Brilinta

Data from THEMIS trial in type II diabetes and previous MI/stroke

2H19

Imfinzi/Lynparza

Primary completion of BAYOU Phase II trial in 1L cisplatin ineligible urothelial cancer

2H19

Tagrisso

1L OS data

2H19

Lynparza

Data from Phase III PAOLA-1 trial in 1L ovarian cancer

2H19

Lynparza

Data from Phase III PROFOUND trial in 2L prostate cancer

2H19

Imfinzi/tremelimumab/chemo

Data from POSEIDON Ph III trial in 1L NSCLC

2H19

Imfinzi/tremelimumab/chemo

Data from CASPIAN PhIII in SCLC

2H19

Imfinzi/tremelimumab

Results of DANUBE Phase III trial in 1st line bladder cancer

2H19

PT010

Results from ETHOS Phase III trial of triple combo in COPD (exacerbations)

2H19

Calquence

Results of Phase III trial in 1L CLL with and without Gazyva

2H19

Calquence

Data from head-to-head Ph III trial vs Rituxan in r/rCLL

25Page

2019

Epanova

CVOT data

Source: Deutsche Bank

26 Page

Summary model

Figure 41: AstraZeneca summary P&L

USDm ex-per share

2016A

2017A

2018E

2019E

2020E

2021E

2022E

2023E

Product sales

21,319

20,152

21,092

22,716

25,790

28,174

30,198

31,379

Externalisation revenues

1,683

2,313

1,000

1,100

900

750

750

750

Total revenues

23,002

22,465

22,092

23,816

26,690

28,924

30,948

32,129

Gross profit

19,130

18,477

17,861

19,515

22,027

23,824

25,314

26,161

Gross margin %

83%

82%

81%

82%

83%

82%

82%

81%

Other op. income

1,717

1,953

2,236

1,100

900

700

700

700

Operating profit

6,721

6,855

5,993

6,543

8,196

9,589

10,860

11,480

Profit before tax

6,027

6,150

5,108

5,671

7,352

8,739

10,056

10,726

Tax expense

(658)

(860)

(919)

(992)

(1,287)

(1,529)

(1,760)

(1,877)

Tax rate %

11%

14%

18%

18%

18%

18%

18%

18%

Core net income

5,455

5,423

4,308

4,798

6,185

7,210

8,296

8,849

Core EPS

4.31

4.28

3.41

3.79

4.89

5.70

6.56

7.00

Source: Deutsche Bank, Company data

Figure 42: Rebased change in 2019E consensus earnings forecasts

Figure 43: Sales and EPS growth 2016A-2023E

1.10

35,000

7

change

1.00

30,000

8%

7%

6

rebasedEPSconsensus

(USDm)Revenue

10,000

23%

22%

8%

2

(USD)EPSCore

25,000

10%

5

0.90

12%

45%

46%

20,000

4

24%

17%

43%

21%

41%

0.80

15,000

16%

29%

35%

3

20%

19%

17%

17%

22%

20%

23%

2020E

0.70

5,000

38%

36%

31%

31%

30%

30%

30%

30%

1

0.60

-

0

Feb-15

Jul-15

Dec-15

May-16

Oct-16

Mar-17

Aug-17

Jan-18

Jun-18 Nov-18

2016A

2017A

2018E

2019E

2020E

2021E

2022E

2023E

Deutsche

Source: Deutsche Bank, Bloomberg Finance LP

Source: Deutsche Bank, Company data

Respiratory & Inflammation

AstraZeneca

Cardiovascular

Oncology

GI/other

AG/London Bank

Bank Deutsche

Bayer (Buy; PT €115)

A special situation: the questions is how to realise the significant value potential

AG/London

view, management has struggled to provide a convincing message as to what Bayer is, why it exists in its current form, and of the superior returns

■

Equity story muddled but slanting to crops. The acquisition of Monsanto has resulted in fears of significant product liability risk and earnings

downgrades. As a result, Bayer's shares trade on 8.5x 2020 PE, a significant 40% discount to peers despite a better mid-term growth potential. In our

investors could expect. For the shares to perform, we believe investors need to see a confident and consistent message from management, gain more

clarity on the likely glyphosate based liability (albeit a significant risk, ahead of most past precedents is already priced in) and a see more favourable

performance from the higher value crop business. While Bayer has announced cost savings measures and small divestments, should performance

(and the share price) not improve, shareholder activism could become more vocal. This makes Bayer a special situation in the near term.

■

Litigation. Unpredictable but extremes priced in. With limited Pharma newsflow expected and CropScience awaiting a improvement in the cycle

(weather), 1H19 is likely to be dominated by glyphosate litigation news. The first of the federal bellwether trials starts in February and we expect

volatility on the verdict. Unfortunately, precedent suggests a potential announced headline settlement of the near 10,000 current outstanding claims

is unlikely to be reached in 1H19 so trial outcomes (and the volatility they come with) will direct the shares. As any individual trial outcome is unlikely

to predict the final outlook, timing of investments on this theme is di cult. Longer-term however, our work shows that past precedent cases result

in settlements of 100-300k per claimant despite larger initial headline awards. Based on this analysis, it can be argued that the share price reflects

more than ten fold this precedent liability, suggestive of a positive risk/reward profile for the shares.

Figure 44 : Bull/Bear case price target impact (€/share)

Figure 45 : PE Company vs. EU Pharma – 1 yr FWD PE

140

1.1

131

1.4x

1.7

13.1

Rel. PE

130

115

10yr Ave

120

44.2

0.9

+/- 1 s.d.

1.2x

110

fwd

(€)

priceShare

100

1yr(x),sector

90

1.0x

80

1.1

69

to

70

rel.

0.8x

60

PE

50

Bear

Finerenone failure

Glyphosate:Settle 50,000claims at $1meach

Glyphosate: Settle20,000 claimsat $300k

each

Base(includes $5bnof G liabilities)

Removalof conglomerate discount

Daralutamide $2bnat peak

Finerenone PhaseIII (moderate success)

Bull

Jan 09

Aug 10

Apr 12

Dec 13

Aug 15

Apr 17

Dec 18

0.6x

0.4x

Source: Deutsche Bank estimates, * - current share price

Source: Deutsche Bank, Factset

28 Page

Focus for 2019

■

Litigation. A number of glyphosate related product liability trials are due to commence in 1Q19. Highest profile is likely to be the first Federal trial

(Hardeman vs Monsanto) held in California with Judge Chaabria. This will likely act as a bellwether trial to help both sides figure out options for

damages and settlements. Another State trial, again in California, is due to commence in March. A third trial in St Louis, Missouri is also in the process

of being scheduled for early next year. Outcomes from these trials will likely set the tone for the Bayer shares in 2019.

■

Looking to the skies. Bayer's CropScience division is clearly an attractive asset with a market leading position in a long term growth area. However,

with low soft commodity prices driven by repeated strong harvests, the division is currently operating at 'trough' levels. We see a potential improvement

in fortune as the market tightens due to trade tensions between the US and China. Furthermore, we expect Bayer's share price to be driven should

there be for cues from the weather, and/or farmer's planting behavior as the year progresses. Once investors believe Crop is out of its trough cycle,

we expect this to be the primary sentiment driver for the shares.

■

2019 a year of pipeline? We expect: 1) the roll out of Vitrakvi for TRK fusion cancers in early 2019 (not share price moving until Bayer can demonstrate

patient capture in this di use group of patients): 2) presentation of daralutamide's ARAMIS trial in castration resistant prostate cancer at a medical

conference in 1H19 (share price moving if it demonstrates an e cacy advantage or clear safety benefit vs already launched competitors); 3) We do

not expect Bayer to announce results of the finerenone diabetic kidney disease trials during 2019, albeit primary completion of the FIDELIO-DKD

trial is currently listed for October.

Key news flow

Figure 46 : Potential key news flow

Timing

Event

Description

Feb-19

Glyphosate trial

First federal 'bellwether' trial starts

Mar-19

Glyphosate trial

Second state trial

Mar-19

copanlisib

Safety data from monotherapy trial in rituximab-refractory iNHL (CHRONOS-2)

Mid-19

Portfolio disposals

Progression of plans to dispose of assets, including Animal Health & certain Consumer Health

brands

1Q19

Manufacturing inspection

FDA re-inspection of Leverkusen manufacturing facility

Oct-19

vericiguat

Results from Phase III VITALITY trial in HFpEF

2019

darolutamide (ODM-201)

Presentation of ARAMIS Phase III results in non-metastatic castration-resistant prostate cancer

2019

darolutamide (ODM-201)

Expected regulatory filing and approval decision

Source: Deutsche Bank, Company data

AG/London Bank Deutsche

Deutsche

Summary model

Figure 47 : Bayer summary P&L

Bank

€m (EPS €)

2016A

2017A

2018E

2019E

2020E

2021E

2022E

2023E

AG/London

Sales

34,943

35,015

39,124

45,918

47,347

49,014

50,605

52,424

Reported EBIT

5,738

5,903

5,157

5,951

7,101

8,138

9,346

10,615

Gross profit

23,187

23,633

25,843

30,292

31,612

33,032

34,473

36,078

Gross margin

66%

67%

66%

66%

67%

67%

68%

69%

Underlying EBIT

6,826

7,130

6,536

8,210

8,860

9,647

10,475

11,244

Margin %

20%

20%

17%

18%

19%

20%

21%

21%

PBT

4,773

4,577

3,828

4,081

5,329

6,502

7,846

9,257

Net income before MI

3,756