Jazz Pharmaceuticals plc (JAZZ) has enjoyed an extended rally thanks to headline-grabbing announcements in the past few months. Once lifted in August, the company’s revenue outlook needs a further upgrade per our analysis of historical data in light of ongoing product launches. JAZZ’s liquidity is robust enough to weather the effect of declining cash flows even as the management expects the margins to come under pressure amid the ongoing product launches and clinical trials.
As generics make the market entry rivaling the company’s leading drug Xyrem, a new product launch is underway, targeting a swift conversion of the existing patient base. Meanwhile, moves are afoot to bolster the oncology franchise highlighting the attempts at revenue diversification. Our EBITDA forecasts for the year beat the consensus estimates, and with the current forward EV/EBITDA multiple, it indicates a modest undervaluation. Yet, despite a series of catalysts ahead, JAZZ continues to underperform the market on a YTD (year-to-date) basis, encouraging us to raise its outlook to a ‘Buy’.
Catalysts Spark a Rally
After the emerging competition and a failed late-stage clinical trial darkened its prospects in the first few months of the year, Jazz Pharmaceuticals has made a remarkable turnaround lately, forcing the management to roll back the dreary outlook they set earlier. Thanks to a series of catalysts and the upgraded guidance, the stock had made a swift comeback gaining ~41.3% in the past six months, outperforming the ~26.1% rise in the NBI (NASDAQ Biotechnology Index). In June, FDA signed off JAZZ’s Zepzelca (lurbinectedin) for adults with relapsed metastatic SCLC (small cell lung cancer) on or after platinum-based chemotherapy. One of the two types of lung cancers, SCLC has a poorer prognosis compared to NSCLC (non-small cell lung cancer), highlighting the importance of the development for an indication which did not have an approved second-line therapy in twenty years. With U.S. commercial rights from Pharma Mar, S.A., JAZZ was, therefore, quick to roll out the drug in early July.
After the FDA signoff in July, Xywav, targeting both cataplexy and EDS (excessive daytime sleepiness) of narcolepsy, is preparing for the market launch in this quarter for patients older than seven years. It has 92% less sodium compared to the current standard of care, JAZZ’s own Xyrem (sodium oxybate). Therefore, the new drug is a safer therapeutic option for those with narcolepsy as well as other cardiometabolic comorbidities such as hypertension, diabetes, and hypercholesterolemia. Last week, the company announced its latest catalyst: positive top-line data from Xywav in a Phase III trial evaluating the drug’s safety and efficacy in adults with IH (idiopathic hypersomnia).
Source: Seeking Alpha
Revenue Guidance Looks Underwhelming
In light of these developments, last August, the company upgraded its revenue guidance for 2020, which, as shown in the graph, indicates the revenue forecast for neuroscience and oncology franchises in addition to total net product sales and total revenue. In our calculations, the ‘other’ component of the net product sales was derived from the difference between the projection for total net product sales and the total sales of the two franchises. The gap between the total revenue and total net product sales of the guidance indicates the forecast for royalties and contract revenues. The overall revenue guidance of ~$2.2-2.3 billion – the midpoint of which is used for forecasting purposes throughout this article – implies a ~3.9% lift from the prior estimate and ~5.2% growth from 2019. With the consensus estimates indicating only ~4.1-7.3% YoY (year-over-year) growth for the company in 2020, we believe the stock has untapped potential in light of the historical trends and recent developments as highlighted below.
Brighter Prospects for Neuroscience Franchise
The management forecast for JAZZ’s neuroscience franchise, which accounts for more than three-quarters of the company’s net product sales, looks particularly out of touch. The midpoint of the guidance at $1.7 billion forecasts ~7.1% YoY growth for the segment for 2020, a marked slowdown from ~17.2% YoY growth in 2019. With the average number of patients under therapy on the rise despite the pandemic-driven lockdowns, Xyrem, the lead product of the franchise, has driven a ~10.7% YoY growth of the segment in H1 2020 (first half of 2020), backed by a price increase in January. With the revised guidance suggesting only ~3.8% YoY growth for H2 2020, compared to ~18.1% YoY growth in H2 2019, we believe such a drastic revenue slowdown in the Sleep franchise looks overly cautious.
The pandemic is indeed resurging in the U.S., where the company generates over 90% of revenue. But the weekly average of new cases has yet to reach July/August peak when the company upgraded its revenue guidance for the year on account of normalizing patient enrollments as sleep centers reopened. Meanwhile, the joblessness has trended down to reach 7.9% in September from more than 10% in July, and therefore, the impact of unemployment on the payer mix shouldn’t be as bad as feared. After its U.S. launch last year, Sunosi that improves the wakefulness of adults with EDS due to narcolepsy or OSA (obstructive sleep apnea), has made its European launch in May. Moreover, with the market launch of Xywav scheduled for Q4 2020, JAZZ can reach out to a new patient segment of narcolepsy whose comorbidities prevented them from accessing Xyrem before. Given the improving prospects, we expect the Sleep franchise to grow ~11.0-15.0% YoY in H2 2020, leading to ~$1.8-1.9 billion of sales for 2020 with a ~10.9-13.0% YoY growth.
Source: Seeking Alpha
Oncology Segment Shows Promise
Despite a ~26.6% YoY growth in H2 2019, the oncology segment, sourcing more than a fifth of sales, also underlines the management’s caution. It contracted ~7.1% YoY in H1 2020, as supply disruptions impacted Erwinaze sales and the raging pandemic hurt cancer treatments when hospitals focused on COVID-19 care. Now that JAZZ has launched Zepzelca, hospitals, with advanced therapeutic options, are better prepared for a surge in COVID-19 cases. Therefore, we believe the management guidance for the segment, implying ~12.6% YoY growth for H2 2020, needs an upgrade. Assuming ~13.0-15.0% YoY growth for H2 2020, we expect the oncology franchise could contribute ~$485.9-490.6 million for JAZZ’s top line in 2020 at a ~3.0-4.0% YoY growth compared to ~11.0% YoY last year.
Furthermore, per the guidance, the ‘other’ component, accounting for less than 1% of net product sales in the past, could decline ~28.8% YoY this year compared to the ~55.7% YoY decline last year. Royalty and contract revenue, making up a little over 1% of total revenue, could decline ~42.7% YoY from the ~22.0% YoY growth in 2019. Given their marginal contribution to overall revenue growth, we have kept their growth projections for 2020, mostly similar to the management guidance, assuming a decline of ~29.7-28.7% YoY for the former and ~43.9-40.2% YoY decline for the latter.
All in all, our forecasts for JAZZ indicate its total revenue could reach ~$2.3-2.4 billion in 2020, growing at ~8.1-10.0% YoY, better than the ~5.5% YoY growth in the consensus and down from the ~14.3% YoY growth last year.
Margins to Narrow, As Robust Liquidity Cushions Cash Flow Impact
Despite the steady gross margins expected, the management points to pressure on SG&A and R&D expenses as product launches continue amid the ongoing clinical trials. Per the guidance, SG&A and R&D expenses could make up 36% and ~14% of total revenue, respectively, up from ~34.1% and ~13.9% in 2019. Historically, the company’s EBITDA margins have hovered around ~48.1-46.8% from 2017 to 2019, before declining to ~44.7-44.0% on an LTM (last twelve-month) basis in the first two quarters of the year. Given the gloomy outlook for costs suggested by management, we project the company’s EBITDA margins could reach ~44.7-46.8% in 2020, generating ~$1.0-1.1 billion of EBITDA for the year based on the above revenue forecasts.
Thanks to a ~$1.0 billion of notes offering in June 2020, the company’s cash and short-term investments stood at ~$1.7 billion as of Q2 2020, ~57.4% higher than the 2019 year-end. Backed by a borrowing capacity of $1.6 billion available as a revolving credit facility, JAZZ is, therefore, well-positioned to advance the product launches and late-stage clinical trials despite the declining free cash flows as indicated in the graph.
With Catalysts Ahead Modest Premium Looks Decent
Rising only ~3.6% for the year so far compared to a ~19.1% gain in the NBI, the stock has yet to outperform the broader market despite the recent rally, highlighting the untapped potential as confirmed by our relative valuation. With the current forward EV/EBITDA of 9.6x, our EBITDA forecasts for 2020 imply an upside of ~11.3-19.0%. The premium looks modest, but given the long-term prospects of JAZZ as mentioned below, it is strong enough to form a ‘Bullish’ view on the stock.
Xywav To Lead Neuroscience As Oncology Brings Diversification
With the addition of Xywav, the number of marketed products in the neuroscience franchise has risen to three, and four products now lead the oncology segment after the approval of Zepzelca. Backed by the strong liquidity, the portfolio expansion is continuing: two more products await the market entry before 2021. After positive top-line data in the Phase III trial, as mentioned earlier, Xywav is set for a commercial rollout in Q4 2021 targeting IH. The sleep disorder affects an estimated ~37K individuals with no approved therapies. As the indication is often underdiagnosed and misdiagnosed, the available market opportunity should be much larger than the estimates suggest.
However, the company’s leading product, Xyrem, should see a sharp sales decline in 2023 when generics make the market entry. Meanwhile, Avadel Pharmaceuticals plc (AVDL) is planning for a once-nightly oral formulation of Sodium Oxybate after positive Phase III data announced in last April. In response, JAZZ is banking on awareness campaigns to highlight the safety benefits of Xywav, as it aims to convert the majority of its existing patient base to the new therapy by 2023. Furthermore, after a brief pause due to pandemic concerns, the company was scheduled to resume a Phase I trial last August for JZP-324, a low sodium once-nightly candidate of sodium oxybate. Meanwhile, Sunosi, with the EU launch, has just unlocked its overseas potential for OSA as the frequently-underdiagnosed indication has a low drug treatment rate despite impacting an estimated ~16 million of diagnosed patients in the U.S. and leading European markets.
Meanwhile, the company is gradually expanding its Oncology franchise too. A partnership signed with Redx Pharma last month attempts to discover two cancer targets, and the recently-launched Zepzelca could generate hundreds of millions of dollars of peak sales opportunity, according to the management. ZP-458 is currently undergoing a Phase II/III trial in children and adults with ALL (acute lymphoblastic leukemia) and LBL (lymphoblastic Lymphoma) with hypersensitivity to E. coli-derived asparaginase products. Seeking a BLA (Biologics License Application) submission in Q4 2020, the company looks forward to launching ZP-458 in mid-2021.
A series of catalysts have powered a rally in Jazz Pharma. Yet, the historical data in light of the recent developments highlight the need for a revenue upgrade in the management outlook. The margins will come under pressure amid product launches and ongoing clinical trials, but the liquidity is strong enough to outweigh the cash flow pressure. The company is unveiling a new drug to swiftly convert the existing patient base before generics threaten the sales of the leading product. Our conservative forecasts for the year with the current forward multiple indicate a modest premium, but with plenty of catalysts ahead, JAZZ is a ‘Buy’ for us.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.