Vertex Pharmaceuticals currently holds a monopoly in the Cystic Fibrosis market, which can be advantageous for investors. Additionally, Vertex Pharmaceuticals has a promising pipeline for developing drugs for other diseases, indicating potential expansion into new markets. The question remains: Is now the right time to include it in your investment portfolio?
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Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and also briefly go through why the company has meaning to me. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares in Vertex Pharmaceuticals. If you would like to see the stocks in my portfolio or copy my portfolio, you can do so on eToro, You can find instructions on how to do this here. I don't own any stocks in competitors of Vertex Pharmaceuticals either. Thus, I have no personal stake in Vertex Pharmaceuticals. If you want to purchase shares (or fractional shares) of Vertex Pharmaceuticals, you can do so through eToro. eToro is a highly user-friendly platform that allows you to get started with investing with as little as $100.
Vertex Pharmaceuticals is an American biopharmaceutical company that was founded in 1989. Now, the company has four approved medicines that targets cystic fibrosis (CF), a life-threatening genetic disease. These medications are TRIKAFTA, SYMDEKO, ORKAMBI, and KALYDECO. Vertex Pharmaceuticals recently received approval for CASGEV for sickle cell disease, which is the first-ever CRISPR/Cas9-based therapy developed in collaboration with CRISPR Therapeutics. As part of the agreement, CRISPR Therapeutics will receive 40% of the revenue from CASGEV. Vertex Pharmaceuticals also collaborates with Moderna, Entrada Therapeutics, Arbor Biotechnologies, Mammoth Biosciences, Verve Therapeutics, and Tevard Biosciences. Like all other pharmaceutical companies, Vertex Pharmaceuticals has a moat because of its patents. Therefore, investing in pharmaceutical companies, including Vertex Pharmaceuticals, requires staying informed about new treatments, therapies, and patents. None of Vertex Pharmaceuticals' patents are set to expire before 2027 in the United States, while the earliest expiration in Europe is scheduled for 2027 as well. Vertex is a leader in the field of Cystic Fibrosis and faces minimal competition, making it an attractive option for potential investors.
The CEO of Vertex Pharmaceuticals is Reshma Kewalramani. She joined the company in 2017 and assumed the role of CEO in 2020 after serving as Chief Medical Officer and Executive Vice President of Global Medicines Development and Medical Affairs. Prior to her tenure at Vertex Pharmaceuticals, she spent over 12 years at Amgen, holding various positions. Reshma Kewalramani holds a medical degree with honors from Boston University School of Medicine and has completed the General Management Program at Harvard Business School. Assessing Reshma Kewalramani's effectiveness as a CEO is challenging due to her limited time in the position and lack of prior CEO experience. However, it is noteworthy that despite her limited business experience, she was appointed as CEO, reflecting Vertex Pharmaceuticals' preference for leaders with scientific backgrounds to drive their drug development efforts. One reassuring aspect for investors in Vertex Pharmaceuticals is Reshma Kewalramani's commitment to maintaining the pricing strategy of her predecessor, which has been successful in generating higher revenues for the company. Despite her recent appointment, Reshma Kewalramani's extensive industry experience and scientific expertise instill confidence in investing in Vertex Pharmaceuticals.
I believe that Vertex Pharmaceuticals has a moat. While it is premature to assess the current management, I find the CEO's profile promising for advancing the company. Let's now analyze the financials to evaluate if Vertex Pharmaceuticals meets our criteria for a strong competitive advantage. For further clarification on the financial metrics, please refer to "MY STRATEGY" on the website.
The first number I investigate is the return on invested capital, also known as ROIC. I would like to see 10 years of historical data, and we want the numbers to be above 10% in all benchmarks. Before delving into the numbers, it is important to note that Vertex Pharmaceuticals had their first therapy, KALYDECO, approved in 2012, followed by their second therapy, ORKAMBI, in 2016. Hence, it is much more interesting to look from 2016 onwards. Since 2017, Vertex Pharmaceuticals has consistently achieved a strong Return on Invested Capital (ROIC) well above the minimum requirement of 10%. ROIC decreased slightly in 2023, which was a challenging year for most companies due to macroeconomic factors. However, Vertex Pharmaceuticals still managed to deliver a ROIC above 20%, which is impressive. Thus, I'm encouraged by these numbers as Vertex Pharmaceuticals has managed to deliver a consistently high ROIC the year after they launched ORKAMBI.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the percentage growth year over year. The equity decreased slightly before launching ORKAMBI in 2016. However, ever since 2016, Vertex Pharmaceuticals has grown its equity by much more than 10% every year, which is very impressive. Thus, since 2016, Vertex Pharmaceuticals is a textbook example of how you would like to see equity increase.
Finally, we will analyze the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. I use levered free cash flow margin because I believe that margins provide a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected to generate in relation to its market value per share. Vertex Pharmaceuticals has consistently delivered positive free cash flow every year since 2016, following the launch of ORKAMBI. However, free cash flow decreased in 2023, a year that was challenging for most companies due to macroeconomic factors. The levered free cash flow margin also declined in 2023, but it remains relatively high. Therefore, I am not overly concerned, although I would like to see an increase in the levered free cash flow margin in the future. The free cash flow yield, while higher than average, has decreased in 2023. This suggests that the shares are not trading at as attractive a valuation as before, but this is an aspect we will revisit later in the analysis.
Another important aspect to investigate is the level of debt, specifically whether a business has manageable debt that can be paid off within a period of three years. This is assessed by dividing the total long-term debt by earnings. Upon calculating this ratio for Vertex Pharmaceuticals, it is evident that the company has no debt. This is obviously a significant advantage and further enhances the attractiveness of Vertex Pharmaceuticals as an investment opportunity.
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Based on my findings so far, Vertex Pharmaceuticals appears to be a very intriguing investment. However, all investments come with risks, and Vertex Pharmaceuticals is no exception. One significant risk associated with pharmaceutical companies is the loss of patent protection. Patents covering Vertex Pharmaceuticals' products typically provide market exclusivity, which is crucial for the profitability of many of its products. As patents for certain products expire, Vertex Pharmaceuticals could face competition from lower-priced generic or biosimilar products. The expiration or loss of patent protection for a product is usually followed promptly by substitutes that may significantly reduce sales for that product in a short period of time. It is not unusual for pharmaceutical companies to see revenue cut by more than half within a few years following the loss of patent protection. Vertex Pharmaceuticals does not have any imminent patent expirations, as its patents on its five approved therapies expire between 2027 and 2037. Nonetheless, patents will eventually expire, and if pharmaceutical companies cannot replace these therapies with new ones, it will negatively affect their financial performance. Regulatory and Legislative Risks. The U.S. healthcare industry is highly regulated and subject to frequent and substantial regulatory changes. It is anticipated that the industry will continue to face increasing regulation, political actions, and legal challenges as future proposals to reform the healthcare system are considered by the executive branch, Congress, and state legislatures. According to Fitch Ratings, U.S. pharmaceutical companies are encountering escalating legislative and regulatory challenges that could heighten their business and financial risk profiles. Fitch Ratings forecasts that sector margins will be pressured by lower negotiated prices, while regulatory challenges to mergers and acquisitions (M&A) will complicate efforts for companies to address patent cliffs for existing products. Therapeutic focus risk. Another risk for Vertex Pharmaceuticals is its primary focus on therapies for Cystic Fibrosis (CF). While the company has launched CASGEV for sickle cell disease, the vast majority of its revenue still comes from CF treatments. The company estimates that there are approximately 92.000 people suffering from CF in the United States, Europe, and Australia, indicating a limited patient population. Currently, Vertex Pharmaceuticals does not face significant competition in the CF market, but other companies are developing therapies for this condition. One such competitor is the biotech startup Carbon Sciences, which is developing a gene therapy for CF and has received investment from the Cystic Fibrosis Foundation. Although it will take years before this therapy could be marketed, if successful, emerging competition might eventually force Vertex Pharmaceuticals to lower its prices.
There are several compelling reasons to invest in Vertex Pharmaceuticals. One key reason is its strong portfolio of Cystic Fibrosis (CF) therapies. Vertex Pharmaceuticals holds a monopoly in the CF market, and management estimates that 30.000 of the 92.000 people suffering from CF are still untreated, indicating a substantial potential customer base. Additionally, due to improved therapies, people with CF are living longer, thereby increasing the duration they will need Vertex Pharmaceutical's products. Vertex Pharmaceuticals is developing a new vanzacaftor triple combination therapy for CF. Management has expressed satisfaction with the results, as treatment with the vanzacaftor triple combination met all primary and secondary endpoints in the three Phase 3 studies. This new therapy may eventually replace the current CF therapies, thereby extending the duration of Vertex Pharmaceuticals' patent protection for CF treatments. Furthermore, the vanzacaftor triple combination therapy has a substantially lower royalty burden than the current CF portfolio. The existing portfolio incurs a royalty rate in the high single digits, meaning Vertex Pharmaceuticals must pay nearly 10% of its revenue from the current CF therapies to other entities such as Royalty Pharma. In contrast, the new vanzacaftor triple combination will have a royalty rate in the low single digits, allowing Vertex Pharmaceuticals to retain a larger share of its revenue. Diversifying the portfolio. Vertex Pharmaceuticals has historically generated all of its revenue from Cystic Fibrosis (CF) therapies but is now diversifying into new markets. In late 2023, Vertex Pharmaceuticals launched CASGEVY for sickle cell disease. Management believes that 2024 will be a foundational year for CASGEVY, with plans to ramp up patient initiations. In the long term, they anticipate that CASGEVY will be used by thousands of patients and represents a multi-billion dollar opportunity. Additionally, management expects to launch VX-548 in the near future, a therapy for acute pain. They have highlighted the compelling combination of strong efficacy and safety for VX-548, which makes it suitable for treating multiple types of moderate-to-severe pain across various care settings. If approved, VX-548 will be the first of a new class of medicines that inhibit pain signals, representing the first new class of medicines for acute pain in over 20 years. The potential for VX-548 is substantial, as approximately 80 million patients in the U.S. are prescribed medication for moderate-to-severe acute pain each year. Given the massive patient prescription base, the acute pain market is a multi-billion dollar industry, despite the predominance of generic prescriptions. Other potential therapies. Vertex Pharmaceuticals has decided to advance two new disease areas into clinical trials. The first is myotonic dystrophy type 1 (DM1), a serious disease with high unmet need and no approved therapies. This disease affects approximately 110.000 patients in North America and Europe. Vertex Pharmaceuticals has initiated a Phase 1/2 study for its DM1 therapy. The second therapy is for autosomal dominant polycystic kidney disease (ADPKD), the most common genetic kidney disease, which affects approximately 250.000 patients in the U.S. and EU alone. Clinical trials for this therapy began in early 2024. While these therapies may not ultimately be successful, both hold significant potential for the future.
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Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.
The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 13,89, which is from the year 2023. I have selected a projected future EPS growth rate of 13%. Finbox expects EPS to grow by 13,1% in the next five years. Additionally, I have selected a projected future P/E ratio of 26, which is double the growth rate. This decision is based on Vertex Pharmaceuticals' historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $303,03. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Vertex Pharmaceuticals at a price of $151,51 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 3.537, and capital expenditures were 200. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 140 in our calculations. The tax provision was 760. We have 257,7 outstanding shares. Hence, the calculation will be as follows: (3.537– 140 + 760) / 257,7 x 10 = $161,31 in Ten Cap price.
The final calculation is referred to as the Payback Time price. It is a calculation based on the free cash flow per share. With Vertex Pharmaceuticals' free cash flow per share at $12,95 and a growth rate of 13%, if you want to recoup your investment in 8 years, the Payback Time price is $186,68.
I believe that Vertex Pharmaceuticals is an intriguing company due to its monopoly in a therapeutic area. Although the management team is relatively new, I appreciate that the CEO has extensive industry experience. Vertex Pharmaceuticals has consistently delivered a high return on invested capital (ROIC) and a high levered free cash flow margin, which are important metrics for investors. Vertex Pharmaceuticals faces the same risks as other companies in the pharmaceutical industry. Patent expirations will eventually occur, significantly affecting financial results unless Vertex Pharmaceuticals can develop new therapies to offset the losses. This is an ongoing risk inherent in the industry. Another persistent risk is the regulatory environment. The healthcare industry is highly regulated and subject to frequent and substantial changes. Fitch Ratings predicts that sector margins will face pressure from lower negotiated prices, and regulatory challenges to mergers and acquisitions (M&A) will make it more difficult for companies to address patent cliffs for existing products. Vertex Pharmaceuticals generates almost all its revenue from the Cystic Fibrosis (CF) market, where it currently holds a monopoly. The development of new therapies by competitors could impact the company. However, this monopoly in CF is also a significant reason to invest in Vertex Pharmaceuticals. If they succeed with their vanzacaftor triple combination therapy, this portfolio could become even more profitable. Vertex Pharmaceuticals is diversifying into new therapeutic areas, which will lower the company's risk and could significantly increase profits. Both CASGEVY and VX-548 have the potential to generate billions in revenue. Additionally, Vertex Pharmaceuticals has initiated clinical trials in other therapeutic areas. While it is too early to determine the outcomes, these therapies could have a significant positive impact on the company's financials in the future. Overall, I find Vertex Pharmaceuticals to be a compelling investment. However, I require a margin of safety when investing. Therefore, I will only purchase shares if they trade below $240, providing a 20% discount on the Margin of Safety price.
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