Vertex reported healthy first-quarter results driven by continued robust demand for its cystic fibrosis triple-combination therapy, Trikafta/Kaftrio. Quarterly product revenue of $2.37 billion represented a 13% increase from the prior-year period. Vertex is tracking our expectations, and we maintain our fair value estimate of $306 per share and view shares as fairly valued. Vertex’s lengthy patent protections and first-mover status in the lucrative cystic fibrosis market continue to support its narrow economic moat. The company’s positive moat trend is based on its cystic fibrosis drug approvals and its diverse pipeline that continues to make progress.

We forecast over $9.6 billion in revenue for 2023, and we continue to have a positive outlook as Vertex's pipeline develops. Vertex’s most advanced pipeline candidate is its gene-editing drug, exa-cel, which is being developed in partnership with CRISPR Therapeutics for two blood diseases: transfusion-dependent beta thalassemia and sickle cell disease. Exa-cel’s regulatory submissions were completed in the EU, U.K., and U.S., and Vertex awaits a regulatory decision.

Vertex and CRISPR have presented promising phase 3 data for exa-cel demonstrating that the drug has the potential to be a durable, one-time functional cure. We assign a 60% probability of approval to exa-cel and anticipate it could reach the market as early as 2024. We forecast exa-cel could hold strong pricing power and become a blockbuster opportunity. We like that two additional phase 3 studies have been initiated to evaluate exa-cel in pediatric patients, which would broaden the addressable patient population, if approved.

Robust demand for Vertex’s highly effective drug, Trikafta/Kaftrio, is due to the drug’s rapid uptake in the U.S. and strong performance in multiple countries internationally. Trikafta/Kaftrio accounted for 88% of total sales for the quarter.

Vertex Pharmaceuticals, which was once known for discovering Incivek, a blockbuster hepatitis C drug is now overshadowed by a robust cystic fibrosis (CF) franchise. Vertex's approved cystic fibrosis drugs are Kalydeco, Orkambi, Symdeko, and Trikafta, which will make Vertex eligible to treat about 90% of the CF population, assuming international and pediatric approvals. We expect Vertex to maintain its dominant position in CF, given the strong efficacy of its therapies, lengthy patents, and lack of competition, while developing pipeline candidates in other rare indications to spur growth.

CF is a rare indication characterized by a progressive and deadly decline in lung function, affecting approximately 83,000 people worldwide. Since its 2012 launch, Kalydeco has captured most of its target patient population (less than 10% of CF patients with specific genetic mutations) and has become the backbone of combination therapies, including Orkambi, Symdeko, and Trikafta. Orkambi's launch in 2015 expanded the eligible patient population by adding CF patients with homozygous F508del mutations, but its uptake was slower because of its safety profile. Symdeko's 2018 launch didn’t come with any worries over safety and contributed over $700 million in revenue in its first year, targeting the same population as Orkambi plus some additional patients. Trikafta, a triple-combination therapy, has had a very strong launch since its U.S. approval in 2019, and has significantly expanded the company's addressable patient population to heterozygous patients.

Vertex's comprehensive approach has already shaped the treatment of CF and earned it a dominant position worldwide. The chronic nature of therapy and limited competition on the horizon heighten the CF market's attractiveness. Given these positive market dynamics, we think Vertex’s CF program could grow to over $12 billion within our forecast period.

Vertex's pipeline spans several rare diseases, including exa-cel for beta-thalassemia and sickle-cell disease, VX-147 for APOL1-mediated kidney disease, and small-molecule inhibitors for pain. We think the CF franchise will provide ample cash for the development of these candidates.

Vertex's portfolio of patent-protected cystic fibrosis drugs forms the basis of our narrow economic moat rating. The company is well supported by lengthy patent protections extending as far as 2037 and first-mover status in the lucrative cystic fibrosis market. Additionally, Vertex holds significant patient share as nearly 50% of patients worldwide are currently treated for cystic fibrosis using its medicines. More than 30,0000 additional patients worldwide who are currently untreated will be able to seek treatment using Vertex’s recently approved triple combination regimen, Trikafta/Kaftrio. Vertex's marketed drugs Kalydeco, Orkambi, Symdeko, and Trikafta/Kaftrio are the only disease-modifying cystic fibrosis drugs on the market that restore cystic fibrosis transmembrane conductance regulator, or CFTR. They restore proper function to the CFTR protein or correct its production process so that a normal protein is made. Vertex’s portfolio makes up the backbone of cystic fibrosis therapy and supports strong pricing power.

Cystic fibrosis is a genetic disorder affecting roughly 88,000 people worldwide that causes a progressive and deadly decline in the function of the lungs and digestive system. While the number of patients is small, the six-figure pricing for Vertex's disease-modifying drugs creates megablockbuster sales. Vertex's cystic fibrosis portfolio has experienced a pretty welcoming commercial and regulatory environment due to the rarity of cystic fibrosis and the lack of disease-modifying treatments. The market’s attractiveness is heightened by the chronic nature of therapy and limited competition due to the complexity of developing efficient drugs to treat the disease.

Intangible assets are the key moat source for Vertex, as the company benefits from lengthy patent protections for each of its four cystic fibrosis therapies currently on the market. Vertex has been able to build upon its intellectual property, developing better drug combinations that increasingly capture a greater number of patients with various cystic fibrosis mutations. Kalydeco, approved in 2012 for patients with one copy of the G551D mutation, quickly picked up label expansions in additional mutations and age groups, which expanded the eligible patient population from about 1,000 patients in the U.S. when first approved to over 4,000 by 2015. Orkambi was approved in 2015 for patients with two copies of the common F508del mutation. Orkambi expanded the eligible patient population significantly, to over 30,000 globally by the end of 2016. Symdeko, approved in 2018, didn’t significantly expand the addressable population as it targets the same patient population as Orkambi, but it helped capture some additional patients due to its better efficacy.

Trikafta was approved in the United States in 2019, and it was approved in the European Union in 2020 under the name Kaftrio. Trikafta/Kaftrio is a triple combination regimen that further expands the eligible patient population by an additional 30,000 patients worldwide. Just since the beginning of 2021, Trikafta/Kaftrio has been approved and reimbursed/accessible in 12 countries outside the U.S., including Denmark, Germany, Ireland, Israel, Switzerland, the United Kingdom, and Australia. Vertex is awaiting the potential approval of Trikafta in many other countries and in pediatric patients not yet approved for the drug, but we think the eligible patient population for Vertex’s four therapies will reach about 75,000 people, or roughly 90% of all cystic fibrosis patients. Only 10% of cystic fibrosis patients have a genetic mutation that is not currently able to be treated with any of Vertex’s four drugs on the market.

Vertex's strategy has been to use its intangible assets and expertise to build upon its first cystic fibrosis drug, Kalydeco. Symdeko and Orkambi are doublet combinations that add a CFTR corrector to Kalydeco, a CFTR potentiator. Vertex’s most recent drugs to receive approval, Trikafta/Kaftrio, which are triple combination regimens, build on molecules in Symdeko and Kalydeco while layering in a new CFTR corrector, elexacaftor. The complexity and unique mechanism of these drugs results in a new, efficacious therapy that serves as a competitive advantage for Vertex. Many competitors study their own drug pipeline candidates in combination with one or more of Vertex's molecules, illustrating Vertex's position as the backbone of treatment options.

Vertex commands strong pricing power because cystic fibrosis is a rare, chronic condition and there are no alternative disease-modifying treatment options currently on the market. Many patients start treatment for cystic fibrosis in early childhood and continue throughout their lifetime. Trikafta’s U.S. list price at launch reached $311,000, exhibiting the company's strong pricing power. We estimate that Kalydeco, Orkambi, and Symdeko all command pricing upward of $230,000-$250,0000 a year for their therapies. With strong efficacy and pricing power, Vertex's cystic fibrosis portfolio has the potential to contribute over $12 billion in 2032 sales compared with just under $9 billion in 2022.

We believe Vertex does not face significant competition in the cystic fibrosis market. Galapagos (in partnership with AbbVie) was previously its closest competitor, but in 2018 it reported lackluster phase 2 results for its lead candidates, illustrating the high bar of efficacy from Vertex's portfolio. AbbVie initially stepped away from further trials, but then it entered into an agreement to license a cystic fibrosis asset from the Cystic Fibrosis Foundation in October 2019. AbbVie is in the process of two phase 2 studies conducted with the Therapeutics Development Network. We don't see this as a viable threat to Vertex since phase 2 trials are still very early in the drug-development process and it would be years away from potentially reaching the market.

We don't think Vertex's pipeline outside of cystic fibrosis contributes to its narrow moat, as many of its assets are in the early stages of development. However, with Vertex’s substantial cash flow, we think the company is well positioned to continue the research and development of drugs for several rare diseases over the next decade. Further, the pipeline's focus on rare indications with few or no approved treatment options will likely support pricing power. Therefore, we believe it is more likely than not that Vertex will be able to earn excess returns over the next 10 years and warrants a narrow economic moat rating.

We maintain Vertex Pharmaceuticals' fair value estimate of $306 per share. Our valuation remains heavily dependent on the cystic fibrosis portfolio, including its latest drug, Trikafta/Kaftrio. This new triple-combination drug is poised to continue generating strong sales throughout our explicit forecast period.

We model about $9.6 billion in cystic fibrosis sales in 2023, largely driven by Trikafta/Kaftrio, which treats both F508del homozygous and heterozygous patients. Vertex's portfolio of cystic fibrosis therapies allows it to reach 90% of cystic fibrosis patients globally, assuming international and pediatric approvals.

Vertex is using its ample cash on hand from its CF franchise to fund the development of a diverse pipeline, including treatments for kidney disease, type 1 diabetes, and pain, and its pipeline spans multiple drug classes. Vertex is targeting several blockbuster opportunities, which we forecast will contribute over $5 billion in 2032 pipeline sales. Key opportunities include exa-cel (gene-editing candidate in partnership with CRISPR Therapeutics) for beta-thalassemia and sickle-cell disease as well as next-generation CFTR correctors for cystic fibrosis. Exa-cel is co-developed and will be co-commercialized, if approved, with net profits split under a 60/40 agreement with 60% allocated to Vertex and 40% to CRISPR Therapeutics. Vertex and CRISPR Therapeutics have presented promising phase 3 data for exa-cel demonstrating that the drug has the potential to be a durable, one-time functional cure. We assign a 60% probability of approval to exa-cel and anticipate it could reach the market as early as 2024. We forecast exa-cel could hold strong pricing power and become a blockbuster opportunity. We like that two additional phase 3 studies have been initiated to evaluate exa-cel in pediatric patients, which would broaden the addressable patient population, if approved.

We also expect Vertex will continue funding research in cystic fibrosis to develop next-generation therapies for CF, including small-molecule correctors and gene-editing technology. We’ve assigned as 35% base-case probability of approval for Vertex’s next-generation cystic fibrosis therapy, vanzacaftor/tezacaftor/deutivacaftor. Phase 3 clinical trials are underway to evaluate this new once-daily triple-combination regimen that has the potential for superior performance to existing drugs, including Trikafta/Kaftrio, which is taken twice daily.

We assume that selling, general, and administrative expenses as a percentage of sales is in the high-single digits throughout our forecast period. Robust product sales should expand the 2032 operating margin to about 50%.

We assign Vertex a high uncertainty rating. Chronic therapies for rare diseases are often priced above cost-effective levels, and Vertex's cystic fibrosis therapies are priced at least three times the level that cost-effectiveness watchdog ICER would deem cost-effective. We expect Vertex could see reduced exposure to potential pricing pressure with time, particularly if the firm makes headway with gene editing (CTX-001 for rare blood disorders) and cell therapy (VX-880 for type 1 diabetes). Gene and cell therapies have the potential to provide cost-effective, one-time therapies, as shown by recent reviews for approved therapies like Gilead's Yescarta and Novartis' Zolgensma.

Less cost-effective drugs like Vertex's Trikafta/Kaftrio could face U.S. pricing pressure from potential disruptive drug pricing reforms, and our high uncertainty rating accounts for potential pricing pressure from payers or regulators that may depress returns. Also, Vertex's sales from the U.S. are relatively high as compared with its biopharma peer group, which gives more weight to U.S. pricing decisions.

That said, Vertex's concentration in cystic fibrosis is offset by its dominant position and lack of competition. We think the lack of close competition and strong cash generation in the medium term provide a solid cushion, which should allow Vertex to continue diversifying and expanding its pipeline. Vertex's therapies are disease-modifying, but they do not correct the underlying genetic mutation, which leaves room for improvement. While Vertex has a next-generation pipeline in CF correctors and gene editing, competition in gene editing could disrupt the company's successful franchise.

Product governance is also an ESG risk, as failure to adhere to extensive regulations and quality management standards can lead to expensive recalls, increased regulatory scrutiny, compliance costs, and lawsuits from affected customers.

We assign Vertex a Standard capital allocation rating. Our analysis evaluates what we determine to be the three key facets of management decision-making from the perspective of shareholders: balance sheet strength, investment efficacy, and distributions. Our Standard rating results from a sound balance sheet, fair investment strategy, and an assessment of shareholder distributions as appropriate.

Vertex's balance sheet is sound, with revenue cyclicality and operating leverage each possessing a medium rating. The company is in strong financial health, thanks to its robust cash flow generation and low debt. As of year-end 2022, Vertex held over $10.5 billion in cash and equivalents.

We view Vertex's investment decisions as fair and economic profit is increasing throughout our explicit forecast period. In 2019, management wisely allocated capital toward diversifying the pipeline, which included two acquisitions of private biotechnology companies, each presenting a unique market opportunity. Vertex bought Exonics Therapeutics (gene editing in Duchenne muscular dystrophy) for $266 million up front (plus milestones) and Semma Therapeutics (human-derived stem cell islets to cure type 1 diabetes) for $937 million. While these assets remain in early stages of development, we like management's focus on diversifying Vertex's pipeline to ensure future growth, which is well before any of its CF patents reach their expiration. The company is also investing in gene-editing technology in order to create even more innovative and effective cystic fibrosis drugs. We expect Vertex will continue investing in a more diversified rare-disease portfolio as it looks beyond the cystic fibrosis market.

Finally, we assess overall shareholder distributions as appropriate. Even though the company does not currently pay a dividend, we view this as appropriate since Vertex is growing quickly and reinvesting in R&D helps build its value and support its narrow moat.

Dr. Jeffrey Leiden became CEO and chairman in 2012. His experience includes a role as managing director at Clarus Ventures, which specializes in life sciences capital, as well as president and chief operating officer at Abbott. His experience in Big Pharma shone through as he brought Vertex from the cash-burning stage of an emerging biotech to a large, leading biotech firm with an expansive franchise in cystic fibrosis therapies. He has since stepped down from the CEO role and serves as executive chair of the board.

Former chief medical officer Dr. Reshma Kewalramani took on the CEO role in April 2020. Before joining Vertex in 2017, Kewalramani spent over a decade at Amgen. We believe she is well suited to lead Vertex as it expands outside of its cystic fibrosis franchise.

The rest of the management team is composed of other Big Pharma veterans with adequate levels of experience, in our view. Previous CFO Ian Smith was abruptly terminated in early 2019 because of personal behavior. While no details were disclosed, we have no reason to believe that this significantly weighs on the company's stewardship.

Historical controversies related to compensation and other practices don't affect our stewardship rating for the current team. We think management compensation has been historically high, although recent measures spurred by a shareholder vote have curtailed the amounts going forward. In 2014, Leiden's total compensation was $36.6 million, and several senior managers had compensation packages above $10 million. In 2015, Leiden’s total compensation dropped to $28 million in response to shareholder disapproval, and in 2020, it dropped to about $16.5 million. The company has also been probed by the Securities and Exchange Commission for a series of large insider stock sales on positive clinical news in past years.