Vertex Pharmaceuticals Stock: Barclays Downgrade Justified? Not Convinced (NASDAQ:VRTX)

Klaus Vedfelt Investment Overview Vertex Pharmaceuticals (NASDAQ:VRTX), the Boston based Pharma giant with an almost monopolistic share of the Cystic Fibrosis treatment market, announced its Q2 2024 earnings at the beginning of August. Product revenues were $2.65bn – up 6% year-on-year. GAAP R&D and SG&A expenses were $1.3bn, and operating income was reported as $934.9m, resulting in an operating margin of ~35%. Thanks to Vertex’ completion of its $4.4bn buyout of Alpine Immune Sciences, the kidney disease specialist (my coverage of that deal is here), Vertex reported a GAAP net loss of $3.6bn on a GAAP basis in Q2, however in 2023, my research suggests Vertex was the most profitable of any US or European “Big Pharma” company, boasting a net profit margin of 37%. comparison table – Global Big Pharmas key metrics (data collected from TradingView, Google Finance) As we can see in the above table, Vertex’ share price is also the third best performer amongst 15 of the world’s Pharma companies on a three-year basis, up just under 150%, and outperformed only by Novo Nordisk (NVO), and Eli Lilly (LLY). While the reasons for Novo and Lilly’s gains is well documented – they both market and sell GLP-1 agonist drugs, Wegovy and Zepbound respectively, expected to earn hundreds of billions of dollars of revenues in the weight loss industry – the momentum underpinning Vertex’ stellar gains is arguably less obvious. Vertex Cystic Fibrosis (“CF”) portfolio may be completely dominant in its marketplace – lead drug TRIKAFTA/KAFTRIO (US/EU brand names) earned $2.45bn of revenues in Q2, accounting for >90% of the company’s revenues – but penetration is also close to 90%, suggesting there is not much room for further revenue growth in this field, although a nebulised messenger-RNA based therapy being developed alongside Moderna (MRNA) may add ~5k more patients who cannot benefit from CFTR modulators to the addressable market. Vertex stock trades at a value of $476 (at the time of writing), giving a market cap valuation of $123bn. Vertex’s full-year 2024 guidance is for $10.55 – $10.85bn of revenues, with ~$5bn – $5.2bn of SG&A and R&D expenses, therefore, Alpine Immune expenses aside, the company will be exceptionally profitable again in 2024. Nevertheless, the forward price to sales (“P/S”) ratio is >10x, and the historic price to earnings (“P/E”) ratio 34x, both amongst the highest ratios of any Big Pharma, and this is often interpreted as a sign that a company’s stock may be a little overvalued. A few weeks ago, an analyst at Barclays appeared to draw this same conclusion when downgrading Vertex stock to “equal weight”, from “overweight” i.e. Vertex stock is unlikely to outperform benchmark indices. Vertex does have two assets that can make a contribution to top-line growth in the short-to-medium term – the gene therapy Casgevy, approved to treat Sickle Cell Disease (“SCD”) and transfusion dependent beta thalassemia (“TDT”), and a pipeline pain therapy, suzetrigine, which is expected to be approved in early 2025, but both are likely to be commercial slow-burners, and Vertex can hardly become more profitable, so where does Vertex stock find further upside? In prior notes on Seeking Alpha on Vertex, I have tended to give “buy” recommendations, despite some reservations about where revenue and valuation is coming from in the longer-term, and let’s not forget, Vertex is not a dividend payer either. The company has a higher market cap valuation than three companies – Bristol-Myers Squibb (BMY), Gilead Sciences (GILD), and GSK (GSK) – which earned revenues of $45bn, $27bn, and $38bn in 2023, with net profit margins of 18%, 21%, and 16%, paying dividends with an annual yield of 4.7%, 3.8%, and 3.6%. Is there any justification for an investor to favour Vertex over these three companies – which market and sell pharmaceutical products across a range of different indications as opposed to a single market which is almost completely saturated – or indeed any other Pharma company that metrics indicate have better growth potential? In the remainder of this post I’ll try to answer that question by analysing recent developments, long-term outlook, and market dynamics. Is There Any More Room For Growth In CF, & Can Vertex Maintain Its Control Of This Market? Let’s begin by analysing the market that transformed Vertex fortunes as a company and created a Pharma company of global significance. As I wrote in a post on the company in May 2021 (giving the stock a “buy” recommendation – shares are up 130% since): The company was initially focused on viral infections, autoimmune disorders and oncology, before becoming profitable thanks to a Hepatitis C treatment, Incivek. Its first Cystic Fibrosis treatment – Kalydeco – was commercialized in 2012, becoming the first CF therapy to treat the underlying cause of the disease rather than its symptoms. The drawback was that Kalydeco was only able to treat ~6% of all CF patients, but 2 more drugs were commercialized in 2015 and 2018 – Orkambi and Symdeko – both of which were combinations of Kalydeco and another drug. Vertex then began to experiment with triplet combinations for CF treatment, and by 2018 it had developed Trikafta, which presented strong enough credentials to be approved 5 months ahead of schedule, in October 2019, with analysts’ estimates suggesting peak sales of >$6bn. TRIKAFTA/KAFTRIO earned nearly $9bn of revenues in 2023, as Vertex reported total revenues of $9.9bn – up 11% year-on-year, but in 2024, the annual uplift in top-line revenues will be somewhat lower – ~9% – and driven in part by sales of Casgevy. TRIKAFTA/KAFTRIO’s patents do not expire until 2037, and the only meaningful competition in the market comes from – Vertex itself – the company has a Prescription Drug Fee User Act (“PDUFA”) date upcoming in January 2025, when the FDA will rule on whether to approve Vanzacaftor Triple, its latest innovation in the CF space. Marketing applications have also been submitted in the UK and Europe. “Vanza” is a once-daily triple CFTR modulator regimen made up of vanzacaftor, tezacaftor and deutivacaftor. TRIKAFTA is taken twice daily, but Vanza has demonstrated non-inferiority against it in terms of improving lung function, and superiority in terms of lowering levels of sweat chloride. As such, the drug is virtually guaranteed to be approved and be on the market early next year, where it will likely cannibalise sales of Trikafta, which will not concern Vertex. The only question could be whether Vertex is able to charge as much for a once-daily therapy as a twice-daily – will the company’s enviable profit margin attract the attention of the Centers for Medicaid and Medicare (“CMS”), resulting in Vanza, or TRIKAFTA being added to the list of drugs subject to government imposed price controls? Apparently TRIKAFTA costs ~$300k per annum, with patients only paying a fraction of the price, which is covered by health insurers. With that said, some states have formerly considered capping the price of Vertex’ drug to save ~$200k per annum per patient, creating an uncomfortable stand-off. Vertex could threaten to stop supplying its drug in that state, denying patients access to a life-saving treatment. Or, the company could voluntarily cut the price of its drug, as, for example, Eli Lilly, Novo Nordisk and Sanofi (SNY) did last April with the price of insulin. If Vertex did do that, its share price would surely plummet, as unlike the above-mentioned Pharma’s it is dependent on CF for >90% of its total revenues. From the shareholder’s perspective, I would make this the only credible threat to Vertex’s ~$10bn per annum CF franchise, and because there are no competing therapies, arguably, Vertex should be able to charge whatever figure it feels is appropriate without government interference – after all, investment in R&D is producing better and better therapies, which justifies the high price of the drug in many ways. I would advise investors to keep an eye on developments in this space either way, and would also speculate that ~$10 – $12bn is the ceiling for Vertex in the CF space, given high market penetration. In short, CF alone does not justify buying Vertex stock at this time, in my view, but it may provide a source of double-digit billion revenues for another decade, at least. What Contribution To Growth Can Casgevy, Suzetrigine & Inaxaplin Make? Vertex has long maintained that Casgevy is a “multi-billion dollar” per annum revenue opportunity, and in fact, the company paid its development partner CRISPR Therapeutics (CRSP) $900m in 2021 to increase its share of revenues and profits from the drug from 50%, to 60% – a strong show of faith. Casgevy has delivered exceptionally strong results in pivotal studies, providing a “functional cure” for the disease, by upregulating dormant fetal hemoglobin in patients using CRISPR gene editing, and keeping >90% of treated patients free from episodic pain which usually requires multiple hospitalisations per annum for multiple years so far. Being an ex vivo cell therapy in which patient’s cells are harvested, engineered in a lab, and the reinfused back into the patient, the entire treatment process can take up to one year, however, requiring a major commitment from patients, physicians, and health insurers – the therapy has a list price of ~$2.2m. The addressable market currently stands at ~35k patients in the US and Europe, which, multiplied by the $2.2m list price and then by 0.6 (Vertex’s share of profits) implies a total addressable market (“TAM”) of ~$45bn. There are additionally 23k eligible patients in the Kingdom of Saudi Arabia and Bahrain, and Vertex is actively working on ways to make the treatment process more palatable for patients, which could increase the patient pool, including an experimental in vivo therapy. Only 35 eligible treatment centers had been activated as of the end of Q2, with a target of 75, and only 20 patients had had their cells collected, so revenues from Casgevy will likely be negligible in 2024, but longer-term the therapy may have a major role to play in the SCD field. Vertex advised on its Q2 earning call with analysts that it was “pleased to report that we do not see coverage as a significant obstacle to patient access”. Casgevy is not quite a “slam dunk” for blockbuster (>$1bn per annum) revenues, as patients must still be convinced of the benefits of the therapy, long-term safety needs to be established, and there are competing therapies both on the market – Bluebirds’ Lyfgenia – and in development e.g. Editas Medicine (EDIT). Nevertheless, in my view, Casgevy is a major reason for optimism and I would speculate this could become a $5bn per annum selling drug. I should note, the above revenues figures do not include any contribution from the TDT indication, which could easily add another $1 – $2bn to my peak revenues figure. The other near-term shot at blockbuster revenues is Vertex’s pain therapy, Suzetrigine, a “novel, highly selective Nav1.8 pain signal inhibitor” which Vertex says: has the potential to provide a transformative treatment option for the 90 million patients suffering from acute and peripheral neuropathic pain in the US. The non-opioid pain therapeutics market is not especially lucrative at the present time – the best-selling asset may be Pacira Biosicences (PCRX) Exparel, a formulation of Bupivacaine, which earned ~$500m of revenues in 2023. Some analysts have speculated Suzetrigine could generate up to $2bn in peak revenues, although the drug has not always convinced in clinical studies, failing to outperform the painkiller Vicodin (hydrocodone/acetaminophen) in one, and its use could be restricted in a similar way to Exparel. It will take time for Suzetrigine – provided it is approved, which is by far the likeliest outcome – to begin to generate meaningful revenues as deals with insurers are put in place, but with its substantial war chest of >$4.5bn in cash, there is a case to be made that Vertex can succeed where small biotechs with similar products have struggled. In summary, I’d concur with Vertex management that Suzetrigine is a “blockbuster” in waiting, but the jury remains out on whether this is a multi-billion dollar per annum product. Finally, there are the kidney disease assets acquired from Alpine Immune. Vertex is pushing Inaxaplin into Phase 3 studies for APOL1-mediated kidney disease (“AMKD”), a genetic disorder, and has initiated Phase 3 studies for Povetacicept also, in IgA nephropathy (IgAN). Povetacicept (ALPN-303), is a highly potent and effective dual antagonist of BAFF (B cell activating factor) and APRIL (a proliferation inducing ligand). Both Travere Therapeutics (TVTX), with Filspari, and Calliditas Therapeutics (CALT), with Tarpeyo have received accelerated approvals from the Food and Drug Agency (“FDA”) to treat IgAN, with Tarpeyo securing full approval last year, and Travere expecting to secure the same this week. As I discussed in my note on the deal to buy Alpine, Povetacicept is an injectable therapy while the other two are oral therapies, but Povetacicept boasts superior efficacy, albeit in smaller patient sample sizes to date. Kidney disease is extremely tricky to treat and the field is also extremely competitive, with Novartis recently securing accelerated approval for its complement inhibitor Fabhalta in IgAN. Nevertheless, if Vertex can navigate its way through to full approval – at least two years away – I’d speculate the company has another “blockbuster” drug on its hands. Concluding Thoughts – Was Barclays Right To Downgrade Vertex? I’m Not So Sure One thing I’ve learned studying pharmaceutical markets is that some companies become Wall Street darlings – Eli Lilly, Novo Nordisk, and Vertex, for example, and their upside momentum seems virtually unstoppable, running far ahead of what today’s metrics suggest ought to be a sensible valuation. Other stocks – Pfizer (PFE), Bristol-Myers Squibb, and Biogen (BIIB) spring to mind – simply can’t catch a break, despite the former two promising to break >$70bn in peak revenues by the end of the decade, while Biogen, which earned more or less the same revenues as Vertex in 2023, has a market cap valuation 4x lower than Vertex. In short, sometimes it is better to go with “the hot hand” as they say in the NFL. Wall Street, hedge funds, and institutional investors tend to favour the same companies, and ignore the same companies, even when metrics suggest they should be buying the undervalued companies and selling the over-valued. Irrespective of the esteem the company is held in by the biggest investors, Vertex actually does not strike me as over-valued because I believe Casgevy, primarily, but also Suzetrigine and the kidney disease drugs all have “blockbuster” potential, and could drag Vertex towards a peak revenue figure of ~$20bn, perhaps before the end of the decade. There are some headwinds to consider – pricing pressure on the CF franchise, slow uptake of Casgevy, ability of Suzetrigine to make its case as a genuine alternative to opioid-based therapies, intense competition in kidney disease markets – but Vertex, by virtue of not having too diverse a pipeline, can afford to devote all of its time and energy on these assets, and its commercial success in the CF markets is virtually unparalleled. As such, just as I believe that e.g. Eli Lilly stock will break the trillion-dollar valuation barrier sooner rather than later, and before anyone questions whether that is a sensible valuation, I think Vertex’ valuation could quite easily reach $200bn – or 10x my estimated forward revenues circa 2030 – before the market begins to wonder if it is overpaying for shares.

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