By Ivan Deryugin
Recalls in the biotechnology sector don't occur frequently, but when they do, they present severe challenges to the drug manufacturer. For investors, these events also can present opportunities with regard to competing companies and their stocks. The recent recall of Omontys, manufactured by Takeda and Affymax (AFFY), presents an opportunity for investors to profit in Amgen (AMGN). However, the benefits here will not necessarily be driven by incremental sales of Epogen, Amgen's erythropoietin stimulating agent (ESA) and Omontys' primary competitor, but by a change in sentiment surrounding Amgen's ability to withstand competition for its core drugs as it seeks to rebuild its product franchise (Epogen accounted for 11.24% of Amgen's $17.3B, 2012 revenue). I have written about Amgen before, highlighting how the company's aggressive capital deployment is benefiting shareholders and fortifying it against encroaching competitive threats. The recall of Omontys should serve as a reminder to Amgen's critics that the world's largest biotechnology company will not be easily dethroned from its perch atop the sector.
The Impact of Omontys: Examining the Larger Implications
On its own, the Omontys recall will not serve as a material driver of Amgen's 2013 earnings. Most analysts estimate that Amgen will see an incremental 3% boost to 2013 EPS, on the back of around 10% Epogen sales growth, as dialysis providers will be forced to continue to use this monopolistic treatment. The Omontys recall will also serve to increase the probability of Amgen maintaining its relationship with Fresenius Medical (FMS), a key player in the dialysis sector. Incrementally, the Omontys recall is unquestionably positive for Amgen, as it removes (for now) a competing drug from the marketplace. However, I believe that the long-term positives from this event are much more important; they will serve to improve the sentiment surrounding Amgen, and therefore its stock price. As Amgen transformed itself from a startup to the world's largest biotechnology company, it began taking on more and more qualities of "big pharma." Amgen now pays a dividend (and with a yield of almost 3%, it's not far from "big pharma" dividend yields), and EPS growth is no longer driven solely by continued revenue growth. But Amgen took on another aspect of "big pharma" as well: the threat of generic competition. Biosimilars have long been perceived as the prime threat to Amgen, and with biologic drugs, Epogen and Aranesp alone accounting for over 25% of Amgen's revenue, worries over biosimilars (essentially generic biologic drugs) are understandably high. And although Omontys itself is not a biosimilar, Amgen is almost certain to use it as an argument that alternative drugs to its branded biologics can have much different properties and need extensive testing, because patient safety, something that is far more important than cost savings, is questionable.
Traditional generic drugs, usually known as small-molecule drugs, have manufacturing processes that can be easily replicated, and chemical compounds and ingredients that are predicable and well-known, thereby minimizing safety risks. Biosimilars, however, are not identical copies of branded drugs, hence the term biosimilars. Biomolecule drugs, or biologics, are manufactured using living organisms, which inserts unpredictability into the manufacturing process, making it far more difficult to replicate. Proof of the difficulties in establishing safe and effective biosimilars has been abundant in recent weeks and months. Merck (MRK) has shut down its biosimilars unit, scrapping it for a joint venture with Samsung (among Samsung's many business lines is a pharmaceuticals division), with the head of Merck's biologics unit admitting that there has been "volatility" in its efforts to develop biosimilars. Merck now plans to shift its efforts away from biosimilars that explicitly seek to copy existing branded drugs. Other companies have also faced difficulties in creating proper biosimilars. Both Teva (TEVA), the world's largest generics company, and Samsung have abandoned efforts to make a biosimilar version of Rituxan due to difficulties in the development process. Novartis (NVS) through its Sandoz division, now remains the only major company developing such a competitor. Adding to the difficulties of manufacturing biosimilars is that there is a 2nd layer of patents companies can use to protect branded biologics. AbbVie (ABBV) is a prime example. The core patents on Humira, which generates around 50% of its revenues, are set to expire in 2016. However, AbbVie is suing the federal government to claim a patent on the salt and alcohol solution that Humira relies on, and AbbVie CEO Richard Gonzales has stated that AbbVie will utilize 200 different patents, many of which are manufacturing patents, to defend Humira.
Global sales of biosimilars are anticipated to reach $200 billion by 2016, driven by growth in Europe, where the EMA has allowed them since 2005. However, no biosimilar drugs are approved for use in the United States, as the FDA is in the process of laying out the regulatory pathway for such approvals. It's important to note that lobbying campaigns are under way in multiple states across the U.S. to establish fairly restrictive rules regarding the substitution of biosimilars for branded biologics. And while the cost savings of shifting to biosimilars are real, there is skepticism regarding the level of acceptance they will receive amongst the medical community. ISI analyst Mark Schoenebaum has stated that "doctors will (or at least should) wait for proper real-world exposure data before prescribing (biosimilars)…There is just no other reliable way to detect very rare adverse events." Increased scrutiny of potential biosimilars by the FDA is likely, which could serve as another positive development for Amgen, given that long-acting biologic challengers to several of Amgen's core franchises are looming, including Roche's (OTCQX:RHHBY) Mircera (billed as an alternative to Epogen and Aranesp) and Teva's balugrastim (billed as an alternative to Neulasta). But, even as Amgen faces threats from biosimilars, it is embracing them.
At Amgen's February analyst day, the company outlined its long-term growth strategy, and biosimilars form a pillar of the company's plans for continued revenue and EPS growth. The company plans to commercialize 6 biosimilars by 2017. Tony Hooper, Amgen's head of global commercial operations, argued that Amgen's decades of expertise in manufacturing biologics gives it a structural advantage relative to its biosimilar competitors. By 2017, Amgen is planning on launching biosimilar versions of Humira, Remicade, Avastin, Herceptin, Rituxan, and Erbitux, which together generate about $41 billion in peak sales. While Humira may be a difficult drug to copy due to AbbVie's active defense of the drug, Amgen does not need to capture the entire market. With annual revenues of less than $18 billion, Amgen will see meaningful revenue growth if it is able to capture even a small portion of the market for these 6 drugs. We note that developing and commercializing biosimilar drugs takes significant biologic development, clinical trial expertise, manufacturing, and marketing capabilities, all of which, Amgen has. As a result, because biosimilars require full clinical development, these products will actually need to be marketed as "less expensive alternative brands" as opposed to cheap substitutable generics, hence the term biosimilars. A major marketing effort will be needed to penetrate the market with these drugs, and Amgen has such capabilities.
Setting the Stage for Long-Term Returns
There are certainly more exciting companies in the biotechnology sector than Amgen. As the world's largest biotechnology company, the days of annual returns in multi-fold percent range are behind Amgen. However, that does not mean that the company does not have a place in the portfolios of biotechnology investors. Amgen raised its earnings guidance for 2013 at its recent analyst day to $7.20 in EPS at the midpoint of prior guidance, up from a prior estimate of $7; due to tax credits the company is owed for previous legal settlements. EPS is set to grow by 10.6% in 2013, even as revenue is estimated to grow by just 4.26%. Amgen is utilizing buybacks, as well as continual operational improvements, to leverage sales growth and grow its EPS at a faster pace. And the trend is set to continue in 2014. In November, Amgen's Enbrel profit-sharing agreement with Pfizer (PFE) will be converted into a royalty payment, resulting in an $800 million boost to operating income according to CFO Jon Peacock. And Amgen has guided for 2015 earnings of "at least" $8 per share, representing 11.11% growth in 2 years.
There is another element to the Amgen story that biotechnology investors should be aware of: a new commitment to dividends. Admittedly, most biotechnology investors don't invest in the sector for dividend income. However, if that dividend income can create share price appreciation, it shouldn't be discounted. CFO Jon Peacock has committed Amgen to returning, at a minimum, 60% of its net income to its shareholders, and said that the company will shift its focus to dividends and away from buybacks (though he noted that buybacks will remain a part of Amgen's capital return strategy). Why is this important? An increased commitment to dividends will attract a new class of investors. At current levels, Amgen's shares yield just over 2%, set to grow as the company steadily increases its payout. Amgen has grown its dividend by an average of 30% in 2011 and 2012, and sustained increases are likely to attract traditional "big pharma" investors to Amgen in a more material way. As the past few years have shown, relatively high yields and dividend growth in the pharmaceutical sector has served to shield the sector's investors from worries over the industry-wide "patent cliff," as many investors in companies such as Pfizer or Merck are unwilling to part with the dividends that these companies pay. If Amgen is able to attract such investors in a more meaningful way, it will create a core group of investors that will reduce Amgen's volatility even further than the company's steady buybacks and execution have done in the past several years.
I don't believe that biotechnology portfolios should be built exclusively around development-stage companies. As I have stated in prior reports on Amgen, I believe that Amgen's continued focus on protecting its core franchises, investing in the future, and aggressive capital deployment will serve investors well. Even with shares hovering near all-time highs, Amgen currently trades at less than 14x estimated 2013 EPS, a discount relative to its biotechnology peers (share prices are accurate as of the close of trading on March 4, 2013, and 2013 EPS estimates are provided by Zacks).
Big 4 Biotechnology Forward Multiples and Forecasts
|Amgen||Biogen Idec||Celgene||Gilead Sciences|
|2013 EPS Growth||+8.6%||+15.31%||+3.26%||+4.1%|
|2013 PEG Ratio||1.7x||1.7x||6.6x||5.5x|
Importantly, growth is what investors pay for in the biotech sector, so using financial metrics that are centered around growth make significant sense. That is why the "PEG" ratio (or price divided by earnings divided by growth) is something I think is very important to gauge when a biotech company is in fact "cheap" relative to its peers. Notably, for 2013, Amgen's PEG ratio is tied with Biogen Idec (BIIB) at 1.7x, a substantial discount to both Celgene (CELG) and Gilead Sciences (GILD). In my view, Amgen's shares, even near all-time highs, are highly attractive based on growth multiples, and have continued upside potential. AMGN should be seen not as a stock that will generate overnight profits, but as a core holding around which to build a solid, well-rounded biotechnology portfolio.
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