The Bull Case for SNY’s Diabetes Franchise

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Richard Evans / Scott Hinds / Ryan Baum

SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

203.901.1631 /.1632 / .1627

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@SSRHealth

December 5, 2014

The Bull Case for SNY’s Diabetes Franchise

  • 2017 consensus for SNY’s US basal insulins fell from $9.9B to $7.5B after the company warned 2015 sales growth would be flat, citing price competition. We believe estimates have fallen too far, and imply an unstable pricing environment with significant downside risks. In contrast, we believe current levels of US net pricing are at the very least stable, and may improve
  • Key facts: there are only two entrants in the basal insulin market; the market laggard (NVO’s Levemir) is an imperfect substitute for the market leader (SNY’s Lantus); SNY’s pending Lantus replacement (Toujeo, 1Q15) makes Levemir an even less perfect substitute; the entrants cooperate on price rather than competing on price; absolute net pricing levels are relatively low (about $60 / month); and, total basal insulin sales are only about 3% of total US drug spending
  • Because average Rx prices and total category spending are relatively modest, and because Levemir is an imperfect substitute for Lantus (and ultimately Toujeo), it is extremely unlikely that a large number of US payors will attempt to shift a large number of US patients from Lantus (or Toujeo) to Levemir. Having no reasonable prospect of large unit share gains NVO has no motive to price Levemir below Lantus
  • Instead, NVO has cooperated (and in all likelihood will continue to cooperate) on price. All of the US list pricing actions on Lantus and Levemir have fallen within 25 days of each other since at least 2009; on average the companies have raised list prices within 12 days of one another. The most recent price increases occurred in early November; both companies raised US list prices by 11.9%
  • SNY’s problem isn’t NVO – NVO couldn’t possibly be more cooperative, and they’ve done nothing to undercut pricing recently. SNY’s problem is payor frustration with the rate of price increase in the category. Being the category leader, SNY’s Lantus is the natural target of that frustration
  • Lantus lost less than 2 percent new unit share to Levemir in any given year from 2010 to 2013; however as price increases accelerated to more than 40% in 2014 (from more than 20% in 2013) a small but meaningful group of payors pushed back, and Lantus lost more than 4 percent new unit share to Levemir in the first 3 quarters
  • SNY increased its Lantus rebates in response, so that Lantus’s net price is now about 7% greater than Levemir’s as opposed to the 15% premium Lantus carried in 2013. It was SNY who blinked, not NVO
  • NVO almost certainly will not lower Levemir’s price (list or net), and SNY almost certainly will not move to a price (list or net) below Levemir’s. Payors cannot mount a wholesale shift of patients from Lantus to Levemir, because Levemir isn’t the right drug for the majority of patients, and the resulting non-Rx medical costs from a wholesale Lantus to Levemir shift would more than outweigh any savings from lower drug prices. The worst case scenario is that Lantus’s net price (currently $63.54 / month) falls 7% to the Levemir level ($59.12), and that list price growth in the category simply ends
  • The more likely scenario is that Lantus’s net pricing falls to the Levemir level, but that category list price growth falls at most to the industry rate (+/-13%) rather than ending altogether. Toujeo should at least stabilize SNY’s basal insulin share, and in all likelihood should regain modest share from Levemir
  • All in, SNY’s US basal insulin sales in 2015 could be +/-8% lower than 2014 (assuming zero list price growth), or more likely at least roughly flat (assuming some degree of list price growth is preserved). After 2015, stable market share and net price growth at the industry rate imply high single digit to low double digit sales growth, leading to 2017 sales potential of roughly $9B – $1.5B above current consensus

Where we’re BULLISH (changes highlighted): Biopharma companies with undervalued pipelines (e.g. VRTX, BMY, SNY, GSK); Biopharma companies with pending major product approvals (e.g. TSRO, ALKS, HLUY, EBS, BMY, BCRX, CBST); ABBV and ENTA on sales prospects in Hep C; CFN, BCR, CNMD and TFX on rising hospital patient volumes; XRAY and PDCO on rising dental patient volumes and rising average dollar values of dental products and services consumed per visit; CNC, MOH and WCG on bullish prospects for Medicaid HMOs; and, DVA and FMS for the likely gross margin effects of generic forms of Epogen

Where we’re BEARISH: Biopharma companies with overvalued pipelines (e.g. GILD, ALXN, SHPG, REGN, CELG, NVO, BIIB); PBMs facing loss of generic dispensing margin as the AWP pricing benchmark is replaced (e.g. ESRX, CTRX); Drug Retail as dispensing margins are pressured by narrowing retail networks and replacement of AWP (e.g. WAG, CVS, RAD); and, suppliers of capital equipment to hospitals on the likelihood hospitals over-invested in capital equipment before the roll-out of the Affordable Care Act (e.g. ISRG, EKTAY, HAE, VOLC)

Summary

In its 3Q14 earnings result SNY lowered forward sales expectations for its diabetes franchise, pointing specifically to price pressures on Lantus in the US. US Lantus sales are two-thirds of global Lantus sales, and global Lantus sales are a quarter of SNY’s global brand Rx sales. SNY shares fell 16% that day, and after a partial recovery remain 11% below their price on the day preceding the earnings release. We believe estimates have fallen too far, and that SNY is likely to represent a strong value

Background

Lantus (SNY) and Levemir (NVO) are the two long-acting ‘basal’ insulins in the US; trailing 12m net US sales for the two brands total roughly $7B, $5.5B for Lantus and the balance for Levemir

Both products have raised their US list (i.e. ‘WAC’)[1] prices very rapidly and in parallel (Exhibit 1); in fact over the last 5 years all of the US price increases for one brand were taken within 25 days of the other, with the average lag being only 12 days (Exhibit 2)

Lantus and Levemir are highly similar, but are far from perfect substitutes. For most patients Levemir requires more frequent dosing and so is less desirable than Lantus; however for a minority of patients Levemir is preferred, in large part because its shorter duration of action allows therapy to be more precisely tailored

Both companies discount their products; Lantus’s discount has been smaller than Levemir’s though the gap has recently narrowed (Exhibit 3). Focusing on Exhibit 3, there is very little evidence that NVO sharply changed its discounts – contrary to the conventional wisdom. Instead, all indications are that SNY significantly increased its discounting, which had the effect of narrowing the historic net price premium that Lantus carried relative to Levemir (Exhibit 4)

NVO’s pricing behavior isn’t the problem; SNY could hardly ask for a more cooperative 2nd place brand. The issue is payor pushback — SNY simply increased Lantus’s price too quickly. Basal insulins are only 3% of US prescription sales, but list price has grown at a greater than 40% annual rate thus far in 2014, as compared to the roughly 13% rate for prescription brands on average. This obviously draws attention, and it appears this remarkable price acceleration has finally drawn the inevitable payor response – forcing SNY (not NVO) to alter its pricing behavior

Lantus’s share of new prescriptions fell by less than 2 percent in any year from 2010 to 2013. In 2014, as list pricing accelerated from 2013’s annual rate of 24% to more than 40%, some payors shifted demand to Levemir, causing Lantus’s share of new prescriptions to fall by more than 4 percent in the first 3 quarters alone

So what happens next?

NVO is a price-follower who knows it has limited opportunity for unit share gains. NVO generally can expect ‘co-preferred’ status for Levemir, but cannot reasonably expect sole preferred status for a large percentage of patients. Unless patients need Levemir’s greater dosing flexibility to reach target, Levemir’s shorter duration of action simply means two injections daily instead of one, which translates into lower rates of compliance and higher non-Rx medical costs. Without any prospect of outsized share gains NVO has no reason to cut Levemir’s net pricing

We don’t expect average list pricing in the US basal insulin market to disappear (or fall) outright, but we do believe Lantus’s net price premium relative to Levemir will narrow, and that rapid WAC price growth is likely to decelerate. This points to likely flat sales for Lantus in 2015, followed by the potential for more modest growth in subsequent years

In rough numbers, Lantus’s net monthly price is likely to fall about 7% to Levemir’s net price (currently $63.54 v. $59.12). Lantus’s total Rx share will average around 77% for 2014; keeping with historical trend, if we assume this falls to roughly 73% in 2015 we would expect a roughly 5% unit decline if market volume were flat. Total US Rx growth for the category is in fact running at roughly 4% (Exhibit 5); this limits the effect of share losses, leaving a roughly 1% expected decline in units, and a roughly 8% decline in US sales. Share losses might be larger creating limited downside to the estimate; conversely list price growth will in all likelihood fall at most to the industry rate of +/- 13% instead of collapsing entirely, thus negating a decline in sales. SNY increased Lantus’s WAC by nearly 12% in early November – after the 3Q14 earnings report – lending support to the odds of continued WAC inflation

Crucially, SNY is likely to launch Lantus’s replacement (Toujeo) in 2015; Toujeo makes Levemir an even less perfect substitute, and should serve to stabilize SNY’s share of basal insulins, and also to re-establish a modest net price premium vis a vis Levemir. It’s also reasonable to expect that Toujeo would help put the category’s rate of list price growth back up to the industry’s +/- 13% rate of growth. Once Toujeo launches, stable to slowly improving unit share in a 4% unit growth and +/- 8% net price growth[2] market is a reasonable proposition for the early years of Toujeo’s lifecycle, provided Lantus biosimilars and NVO’s follow-on to Levemir (Tresiba) continue to face US regulatory delays

What’s in consensus?

Before SNY’s 3Q14 earnings release, consensus US forecasts for SNY’s basal insulin franchise grew from roughly $8B in 2014 to roughly $10B in 2017 – a 6.7% CAGR. Following the release, consensus estimates call for sales to be flat to down, at around $7.5B through 2017. Nearly all of the drop in basal insulin expectations comes from negative revisions to Lantus (Exhibit 6)

We believe the more likely scenario is for SNY’s US basal insulin sales to be flat in 2015, resuming high single to low double-digit growth thereafter. This implies US sales potential of roughly $9B for 2017, $1B lower than the pre- 3Q14 consensus, but $1.5B higher than current consensus

  1. WAC = wholesale acquisition cost = ‘list’ price
  2. Net price growth generally lags list price growth because of price protection clauses. Also, the current +/- 13% rate of brand price growth is exceptional – we expect list pricing growth to return to its 8 – 10% level
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