Morningstar - Q3 2022 - 68

Investors
Lallos: So, this capsule system factors into
the Morningstar Uncertainty Rating as well as the
Sustainalytics ESG Risk Rating?
Andersen: That's right. The Uncertainty Rating
is the key area where it makes sense to
incorporate the long-term risk of crackdowns on
drugs that aren't cost-effective. If a capsule
score is less than 4, we consider that a red flag
and a potential reason to raise our Uncertainty
Rating for one of these firms. We raised our
Uncertainty Ratings for three firms-AbbVie ABBV,
Amgen AMGN, and Vertex Pharmaceuticals
VRTX-from Medium to High.
Vertex stands out as the worst performer. Its
cystic fibrosis drugs are extremely innovative, but
they're priced at multiples of what ICER thinks
they're worth. And Vertex is very heavily reliant on
those drugs for its profitability. For Amgen and
AbbVie, the culprit is immunology therapies.
There are a lot of drugs for diseases like arthritis,
psoriasis, asthma that tend to be overpriced, I
think partly because insurers feel the need to cover
a wide range of products, so they have less
negotiating leverage. Amgen has an older arthritis
drug, Enbrel, and a newer asthma drug, Tezspire,
that both look overpriced. AbbVie has one
of the most famous overpriced drugs, Humira.
Lallos: What companies look good by this measure?
Andersen: The capsule system confirmed our past
ESG research for some top scorers. Companies like
Sanofi SNY and BioMarin Pharmaceutical BMRN
have done well in past reports, and they did well
here. Sanofi gets a lot of their sales and profits
from Dupixent, which is priced very appropriately
in atopic dermatitis. BioMarin has a hemophilia
gene therapy that isn't yet approved, so technically
not priced yet, but ICER believes that this drug
could be worth as much as $2.5 million. BioMarin
has echoed that it intends to price it around
that level. Roctavian is an example of a treatment
that can be given one time, and a patient may
not need any treatments for another six or more
years. That can be very cost-effective in a market
where annual treatment can cost $600,000.
Lallos: How are valuations for these companies
as of mid-June?
Andersen: As of June 13, the median price/fair
value estimate of the 18 names in the report was
68
Morningstar Q3 2022
0.93, implying that the group is slightly
undervalued. There are some companies that are
more undervalued and some that are even
slightly overvalued right now. The largest, most
diversified names with strong dividends tend to be
more fairly valued or even overvalued. More
concentrated biotechs that maybe don't have quite
as strong a moat, maybe don't yet pay a
dividend-those tend to be more undervalued.
Lallos: What names may offer significant upside today?
Andersen: GlaxoSmithKline GSK is one that we like.
Glaxo is criticized for having a weaker growth
outlook than its peers and a weaker pipeline, but
we think that the HIV and the respiratory products
will perform better than expected.
Roche RHHBY is starting to move past a big
headwind that it saw from biosimilar competition
to some of its older cancer drugs. We think
that's going to make the continuing growth of
their newer drugs stand out and be more evident
as we move through this year. They've got
very innovative drugs in hemophilia, multiple
sclerosis, and oncology. They're continuing
to grow very strongly year to year. And they have
a lot of innovation in the pipeline as well.
Among companies leaning more toward
biotech, Gilead GILD also looks undervalued. They
have a dominant HIV portfolio that they're
continuing to refresh and a very novel cell therapy
in blood cancer that's being used in more
and more patients. Also, they've invested a lot in
their oncology pipeline. I think this is going
to be a key year for learning more about
their ability to compete with the more established
oncology companies.
The highest-risk name would be Biogen BIIB.
It also looks the most undervalued. Biogen just
had a terrible year. They had approval of their
Alzheimer's drug, Aduhelm, but that was
followed by a lot of controversy, losing Medicare
reimbursement, and almost no sales of the
drug. At the same time, they were going through
patent expiration for one of their big multiple
sclerosis drugs. It's been a very difficult
time for the company. But at recent prices, Biogen
shares don't incorporate any value for its
pipeline, which still has a lot of mid- to late-stage
programs for neurodegenerative diseases
and other types of neurology programs in areas
like depression and stroke. Some of these
tend to be higher-risk programs, but we still see
Biogen as a leader in neurology research, and they
still have solid long-term potential.
Lallos: Putting aside valuation, for somebody who
has a watchlist of best-in-class companies, what are
the top names that should be on that list?
Andersen: Although it's undervalued, I would
put Roche there because it's one of our favorite
names. It has one of the widest moats in Big
Biopharma, and it's an innovative combination of
new drugs and diagnostics. Eli Lilly LLY and
AstraZeneca AZN also stand out. These are
companies where everything is going right now
in terms of their portfolios and pipelines.
Lilly has a very strong established diabetes
portfolio and immunology and oncology drugs that
are growing really well. Probably the most
exciting thing going on right now is they just got
approval for a new diabetes drug, Mounjaro,
which also just saw amazing data in obesity. That
opens the door to a future use of this drug in
an area that hasn't seen a lot of effective therapies
or very good reimbursement in the past, and
I think that that's about to change.
AstraZeneca is a similar story, but a slightly
different focus. They have a lot of oncology drugs
and rare-disease drugs. One oncology drug,
Enhertu, was just highlighted at a major cancer
conference in early June. Enhertu looks like it's
going to be a very effective drug for a large
percentage of breast cancer patients. They also
recently acquired Alexion, which gives
them a lot of exposure to next-generation
rare-disease drugs.
Lallos: Any final thoughts for investors interested
in this area?
Andersen: The way the market's behaving now,
there are certainly names where there's still
a lot of opportunity for growth and that investors
have shied away from. It could be a good
time to get into some of these more innovative
biotech names. K
Laura Lallos is managing editor of Morningstar magazine.
Morningstar - Q3 2022

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