Warren Buffett and many other top value investors have one simple rule: “Buy good stocks when they’re down.” These days, such investors should be giving a fresh look at Swiss pharmaceutical giant Roche Holding AG (OTC: RHHBY).

 

#-ad_banner-#The company’s stock has slid out of favor following unfavorable results from a pair of high-profile clinical trials last year.

 

One involved Roche’s experimental Alzheimer’s drug, Gantenerumab, which showed such low efficacy that the trial was stopped early. In the second trial, results were insufficient to extend indications for one of Roche’s existing breast cancer treatments, Kadcyla.

 

Since the results of the two trials were released in December, shares of Roche are down roughly 8%.

 

A significant drop in earnings last year, related to a transient spike in operating costs, have also helped turn investors against Roche.

 

 

 

However, it’s only a matter of time before the negative sentiment wears off. Once investors realize that Roche remains a leading provider of cancer drugs and that the company produces robust dividends, the share price could quickly recover.

 

Roche still has Herceptin, Avastin and Rituxan, a blockbuster trio used to treat breast, lung, kidney, blood, colon and a variety of other types of cancers. In 2014, combined revenue for these drugs rose 5% to about $21 billion. Perjeta, a drug developed for use in combination with Herceptin to treat breast cancer, is nearly a blockbuster, generating annual revenue of $964 billion.

 

Moreover, Kadcyla remains a major asset. Hopes have been dashed that the latest clinical trial would have higher efficacy than Herceptin in previously untreated advanced breast cancer. Nonetheless, Kadcyla was approved for advanced cases where other interventions have failed. Annual sales of Kadcyla currently exceed $500 million.

 

With cancer rates still generally on the rise, revenue from Roche’s existing oncology lineup is expected to climb steadily during the next five years, surpassing $28 billion in 2020. This could be a conservative estimate, though, because of Roche’s latest entry into the leukemia market, Gazyva.

 

Gazyva is being positioned as the successor to Roche’s established leukemia medication, Rituxan. The latter is facing greater competition from copycat drugs and will likely see a marked drop in sales after going off-patent in 2018.

 

However, Roche should be able to maintain a competitive edge in the leukemia market, because phase III trials have proven Gazyva to be more effective than Rituxan for both chronic lymphocytic leukemia (CLL) and non-Hodgkin’s lymphoma (NHL), two of the most common forms of leukemia. Gazyva received FDA approval for the treatment of CLL a little over a year ago, and I suspect it will soon be approved for use in NHL patients, as well.

 

At this point, Gazyva sales are only about $50 million a year. But analysts estimate that this drug’s sales will gradually ramp up to at least $1.5-to-$2.5 billion annually by the time the Rituxan patent expires. Results could be even better if trials show that Gazyva can also replace Rituxan as a treatment for rheumatoid arthritis. That is currently a $17 billion worldwide market and set to grow far larger, analysts say.

 

A solid drug pipeline should enable Roche to maintain a firm grip on the oncology market and diversify into other lucrative areas. For example, Avastin, which was originally approved to treat colorectal cancer, recently won multiple other indications. These include malignant tumors of the brain or spine, lung cancer and breast cancer that has spread to other parts of the body. Moreover, the drug is in phase III studies for liver, ovarian, pancreatic and prostate cancers and could eventually prove valuable in ophthalmology.

 

On the cancer front, Roche has several other new and existing drugs in phase III trials including Perjeta for breast and gastric cancers, Zelboraf for skin cancer and alectinib for lung cancer.

 

Beyond oncology, the firm has half a dozen other drugs in phase III trials. Among these: lebrikizumab for severe asthma, etrolizumab for inflammatory bowel disease and ocrelizumab for multiple sclerosis.

 

The blockbuster drug Lucentis, which is already generating annual sales of $1.7 billion as a treatment for one form of diabetes-related eye damage, was approved for a second indication in February.

 

Actemra, Roche’s other FDA-approved rheumatoid arthritis drug, is in phase III studies to determine its efficacy in immunological conditions, which can cause two different types of blood vessel inflammation. Actemra is a blockbuster, too, with sales of $1.3 billion in 2014.

 

Also, consider Roche’s robust diagnostics business, which has annual sales of more than $11 billion (nearly a quarter of the company’s $50 billion total). Lately, this segment has been expanding a bit faster, posting a 6% revenue gain last year versus 4% for the pharmaceutical division overall. Segment results were driven by double-digit growth in two product categories, immunodiagnostics (13%) and tissue diagnostics (10%).

 

The diagnostics segment has a strong pipeline, too, with eight new device launches planned for 2015 in the United States and global markets. These products include five new types of laboratory equipment, two next-generation glucose meters for diabetics and a bedside system that healthcare professionals can use to evaluate blood clotting factors.

 

To boost this division, management also plans to launch nine new screening and diagnostic tests for use in areas such as cardiology, infectious diseases and genomics.

 

Although Roche boosted profits at a steady pace from 2009 through 2013, one-time costs related to impairments, restructuring and a partial debt refinancing led to a 15% drop in earnings last year. But between reduced interest costs, more efficient operations and attractive sales prospects, Roche should quickly resume forward momentum and could even surpass consensus estimates for 6% annual profit growth during the next five years.

 

Roche has long offered uninterrupted growth of its dividend, which rose nearly 11% annually since 2009, to the current $1.04 a share (good for a 3.1% yield). The firm holds plenty of cash and free cash flow is at decade highs, so the drug maker is likely to keep delivering double-digit dividend growth in coming years.

 

Risks To Consider: Keep an eye on the Swiss franc, which quickly shot up roughly 20% against the dollar and the euro and in mid-January, when Switzerland’s government unexpectedly unpegged its currency from the euro. Since Roche is based in Switzerland, an extremely strong Swiss franc could weigh heavily on the firm’s profits.

 

Action To Take –> Following recent price declines, shares of Roche trade for less than 15-times projected 2016 profits. Compare that to rival Bristol-Myers Squibb Co. (NYSE: BMY), which trades for nearly 30-times projected 2016 profits.

 

Notably, Roche’s currency headwinds already appear to be subsiding. The Swiss franc is down roughly 10% against the dollar and 9% against the euro since its mid-January spike.

 

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