Coverage Initiation: Sandoz
Sandoz is a generics/biosimilars giant, with a leadership position in Europe and a dominant presence in other geographies. In recent years the firm’s US operations have been struggling, largely owing to a failed asset disposal deal. Nonetheless, given its greater flexibility post the demerger, the management is aiming to turn around the US business and capitalise on the attractive potential for biosimilars. Moreover, a comfortable leverage position should allow for increasing dividends in the coming years. Hence, we initiate coverage of Sandoz with a ‘BUY’ recommendation.
| Target Price |
Credit Risk |
Fundamental Strength |
Sustainability Score |
Independent Board |
| 35.4 CHF |
BBB |
4/10 |
7/10 |
Yes |
Businesses & Trends
Sandoz, spun-off from the Swiss innovative pharma giant Novartis in late-2023, is one of the leading European pharmaceutical companies focused on the development, manufacturing and marketing of generics and biosimilars. Generics are drugs with the same active substance as the corresponding off-patent branded drugs and are largely chemical-based offerings whereas biosimilars are drugs with efficacy and safety profiles similar to those of the reference biologic drugs and are normally made from living organisms/cells. Since biosimilars are in a relatively nascent stage vs. conventional generics (in use for more than hundred years), the first biosimilar having been approved in Europe in 2006 and in the US in 2015 (for both these geographies, Sandoz was the pioneer), they contributed 21% of Sandoz’s 2022 sales while generics accounted for the bulk (c.79%) of the top line. However, given the higher growth potential of biosimilars (details later) and the firm’s improving pipeline within this class of drugs, the proportion of biosimilars should expand steadily in the coming years.
Sandoz sells its products in >100 countries, supported by six development centers (five in Europe and one in India) and 18 manufacturing sites (13 in Europe, two in the US, and one each in India, Brazil and Turkey). The portfolio includes therapeutic versions of off-patent drugs in a wide range of areas, including oncology, cardiovascular, central nervous system, anti-infectives, pain and respiratory.
Promising target markets
The highly-competitive $208bn (gross sales, i.e. before discounts, rebates and deductions) generics and biosimilars market is expected to grow at an 8% CAGR during 2022-31, supported by the ageing population, an increasing rate of chronic diseases, the mounting healthcare burden on governments and patented drugs losing their exclusivities (LoEs). Within the overall market, while generics are expected to grow at a 5% CAGR in the medium-to-long term, biosimilars may clock a 20% CAGR. The higher growth expectation for biosimilars is largely a result of their being in a relatively early-stage vis-à-vis generics and a significant number of patent expiries in the medium-to-long-term. Moreover, with the US Inflation Reduction Act (passed in August 2022) offering 13 years of market exclusivity to biologic drugs vs. just nine years for small molecules, biologics may attract a higher share of R&D, and eventually benefit the biosimilars market. Overall, backed by a healthy track-record of new and ‘first-to-market’ launches, an increasing share of complex generics and biosimilars, scale, the depth-breadth of the portfolio and longstanding relationships with customers, Sandoz is well positioned to achieve its growth ambitions. Note that Sandoz’s growth targets should not be directly compared with market growth estimates since Sandoz’s outlook is based on net sales (i.e. after discounts, rebates and deductions) and the market estimates pertain to gross sales. Having said that, Sandoz hasn’t been able to clock mid-single digit growth (i.e. c.5%) in any year since 2015. Therefore, the management’s achieving medium-term targets is likely to be something of a litmus test.
Need to know
Persistent pricing pressure
With 1/ increasing competition, including from low-cost producers in China and India; 2/ pricing often set by governments/regulators that intend to reduce them over time; and 3/ a gradually consolidating customer base, pricing pressure should continue to remain an overhang in the coming years. In fact, during 2015- 22, pricing headwinds averaged c.7% p.a. for Sandoz. Therefore, growth for Sandoz (like other firms) should be driven by volumes, geographic expansion and ‘first-to-market’ product launches.
Generics vs. Biosimilars
Typically, with their larger and more complex molecular structure than generics, along with the requirement for clinical trials, the development of biosimilars can take six to nine years vs. just two years for a simple generic, and their development costs range between $100-300m per candidate vs. just $1-2m for standard generics. Consequently, biosimilars are usually priced at lower discounts (i.e. 10-30%) to their originators than generics (potentially up to 80-85%) and are thus high-margin products.
Lackluster stakeholder returns
Over the years, Sandoz’s ROCE and ROE – averaging a respective c.10% and c.9% in 2020-22 – has not been that much above the c.7% WACC. Nonetheless, the return ratios should gradually improve as the firm targets sales and profitability expansion. Despite the promising growth prospects and the management’s operational turnaround plans, unimpressive stakeholder returns and modest cash generating ability have weighed on Sandoz’s fundamental strength score of 4/10 (as per the AV parameters). In summary, Sandoz’s investment case hinges on the management’s ability to turn around the operations and deliver on its promises, which has a fairly decent probability, although the markets are likely to remain skeptical until such time as Sandoz begins to consistently execute its plans.
Investment case risks
Despite the company’s underlying attractiveness, the investment thesis incurs the following risks:
1/ Any delay in turning around the US operations could dent the management’s growth targets;
2/ In the US, pharmacy benefit managers may be inclined to favour high-priced branded drugs because of the financial incentives, meaning that low-priced biosimilar growth promises might not be hurdle-free;
3/ Pricing pressure could remain a challenge for top-line growth and margin expansion;
4/ Innovator firms’ strategies to extend drug patents – including secondary patents and the filing of frivolous petitions with regulators – may impact Sandoz’s growth ambitions
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