DVA / FMS: Generic Epogen Accretive to EPS

Richard

Medicare pays for 85 pct of US dialysis treatment; since 1Q2011 Medicare has paid for treatments on a bundled basis, i.e. with a single payment covering all of dialysis providers’ costs including drugs

Erythropoiesis stimulating agents (ESA’s) are roughly 1/4th of dialysis providers’ treatment costs. As the largest dialysis providers (71 pct combined purchase share of ESA’s used in dialysis), DVA / FMS acquire branded ESA’s for (only) about 8.6 pct less than smaller providers. AMGN is effectively the sole US source of ESA’s for dialysis, and so has little current reason to discount

In or around 2016, generic ESA’s are likely to enter the US market – ultimately we expect two additional ESA sellers (Novartis and Hospira). With three ESA sellers, DVA / FMS’ combined 71 pct purchase share should translate into a significant cost-of-ESA advantage relative to the smaller dialysis providers

If Medicare continues with the bundled reimbursement approach, but lowers the 2016-and-after payments to reflect DVA / FMS’ ESA costs, the smaller providers almost certainly will fail. Alternatively, if CMS adjusts bundled payments to reflect the costs of generic ESA to the smaller providers, under certain (feasible) conditions DVA & FMS could see absolute growth in gross profit dollars per patient

Three conditions must be met: 1) Medicare sets bundled payments so that smaller providers survive; 2) the cost of generic ESA’s to smaller providers stays above a threshold (so that absolute dollar reimbursements are sufficiently large); and 3) DVA/FMS achieve a sufficiently large cost-of-ESA advantage v. smaller providers (creating a gap between the cost of ESA assumed in the reimbursement formula, and the actual cost of ESA’s to DVA/FMS). Conditions 1 and 3 almost surely will be met – Medicare needs smaller providers to survive (condition 1), and DVA / FMS’ 71 pct purchase share all but guarantees significant purchasing leverage (condition 3)

The riskiest assumption (condition 2) is that the cost of generic ESA’s to smaller providers stays above some critical threshold (+/- 50 pct of current ESA cost). There will be at most 3 suppliers of generic ESA, and the manufacturing economics of biologics suggest generics will level off at prices closer to the innovator than has been the case with small molecules
DVA is more beneficially levered to generic ESA’s than FMS, though both benefit: We believe generic ESA’s can prove accretive to DVA’s 2016 EPS across a range of $0.51 to $1.14, implying a potential gain of 10 pct to 23 pct above current 2016 consensus of $4.95. Similarly, we believe generic ESA’s could be accretive to FMS’ 2016 EPS across a range of $0.17 to $0.39, implying a potential gain of 4 pct to 8 pct above current 2016 consensus of $4.75*

*All Fresenius EPS values are expressed per common share, not per ADR (1 FMS ADR = 0.5 shares)

For our full research notes, please visit our published research site

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