Celgene: Going Higher And Higher

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 |  About: Celgene Corporation (CELG)
by: Albert Podell

I have been continuously long Celgene (NASDAQ:CELG) for 18 years, have taken its pulse frequently during that period, and can speak to its outstanding health. I bought it at 70 cents (on a split-adjusted basis) and have held it through thick and thin, including some periods during which, as now, many highly paid but intellectually impoverished pundits and analysts claimed it was overpriced. During this period its value has increased 187 times as it has grown from a tadpole to the third biggest biotech in the world. Each $10,000 invested back in early 1995 has become $1,814,000 today.

I will propose below a very simple method for enabling the average investor to determine whether CELG is overpriced. Very simple, but I do not think simplistic. And I will explain why.

With this stock, you will not have to guesstimate if Apremilast will be used by 50% of America's dermatologists, or 5%. You will not have to predict whether Abraxane, for whose acquisition CELG was widely downgraded several years ago for paying too high a price, will definitely be approved for pancreatic cancer treatment later this quarter. Or worry whether the new drug Kyprolis, recently released by Onyx Pharmaceuticals, will eventually challenge Celgene's Revlimid as the standard of care in multiple myeloma (MM) treatment. And you won't have to wait anxiously for clinical trial data, or catalysts, or incomprehensible reports from specialized medical meetings.

All you have to do is listen to, and rely on, management, because Celgene's management has proven, time and time again, to be smart, honest, frank, knowledgeable, prescient, and conservative in their earnings guidance. They do not hype, push, pander, or flaunt; that is just not part of Celgene's corporate culture. More than 11 times in the past 12 quarters Celgene's earnings have equaled or surpassed both its own guidance and most analysts' expectations, the one exception being the clouded first quarter of 2012, when the downside surprise was 4.4% because of an unexpected and unpredictable statistical anomaly found in clinical-trial data analysis. CELG's otherwise reliable predictions are guides on which I have come to depend, motivating me to hold my stock for almost two decades and purchase many fruitful LEAPS, and they have never let me down.

  • On Jan. 28, 2010, in reporting earnings for its record 2009 fourth quarter and full year, Celgene estimated 2010 earnings of $2.55 to $2.60; those earnings came in, with a solid upside surprise, at $2,80.
  • On Jan. 27, 2011, while reporting those excellent 2010 earnings, Celgene assured investors that "the operating momentum, combined with our continued investment in R&D positions us well for sustainable growth in both the near and long term." At the earnings call that day, CEO Robert Hugin told us that "we have a robust products pipeline that supports a strong sustainable growth trajectory into the future," and indicated that the company would earn a spectacular $8 a share in 2015. And it is right on track to do that. (All of Celgene's earnings reports and projections can be found here.)
  • On Jan. 7, 2013, management upped the ante at the 31st Annual JPMorgan Healthcare Conference. After reaffirming the $8 earnings guidance for 2015, CEO Hugin then gazed a full five years into the future and estimated that, in 2017, Celgene will earn "between $13 and $14 a share." The Motley Fool reported that day that "For 2017, Celgene has targeted a sales figure of $12 billion, double the expected level of 2013. It is also targeting EPS of $13-$14 that year." Citing a plethora of important products emerging from Celgene's pipeline, Hugin declared that "the best days at Celgene are in front of us."

Can Celgene's management be wrong? Of course. Is it likely? No. Are there risks? Yes, and they are set forth toward the end of this article. Are they likely to materialize? Not in my opinion.

Turning a Turn-Down Into a Victory

In my 18 unbroken years as a CELG shareholder, I can recall only three serious instances in which the company was caught off guard, and two of these were far back in its infancy. The first occurred after the company spent heavily to develop an expertise in chiral chemistry, virtually its sole focus in its formative years. Your see, many organic molecules (and a few inorganic ones), without deviating from their chemical formulas, occur in the form of non-superposable mirror images, called cis- and trans-isomers, or right- and left-handed forms, the good and evil twins of pharmokinetics. Celgene had studied the drugs being made and marketed by Big Pharma and discovered that a great number were chiral compounds, containing equal numbers of right-handed and left-handed isomers, known as a racemic mixture. Far from this being a subject of idle curiosity or abstract science, Celgene determined that many of the dangerous side effects of some drugs were caused by the presence of the bad isomer, and it brilliantly developed a technique for removing the bad isomer from a racemic mixture. Wonderful, right? Worth a fortune, you'd think.

But when Celgene tried to persuade Big Pharma to clean up its act and let Celgene clean up those products, the reaction was: Thanks, but no thanks. Celgene was, unexpectedly, met by a solid wall of resistance from these potential customers and almost went out of business.

Fortunately for Celgene, and its pioneer investors, and thousands of patients who are still alive today because of its drugs, its chiral expertise enabled it to realize that thalidomide, the most damned and damaging drug of the 60s, racemized when used, and that its right-hand enantiomer was the beneficial form that prevented morning sickness in pregnant women, while its evil twin was teratogenic, and the agent responsible for causing the phocomelia that resulted in about 15,000 birth defects and limbless children in the 46 countries where the compound had been approved for use by expectant mothers. Celgene tamed the evil twin and created Thalidomid, its first FDA-approved product, for use against erythema nodosum leprosom, a rare complication of leprosy, and then turned the drug's teratogenic properties against many blood cancers. Several years later it introduced lenalidomide (Revlimid), a super-powerful immunomodulatory (IMD) analog of thalidomide that combats multiple myeloma and myelodysplastic syndrome (MPS). Revlimid is now one of the most profitable drugs ever made and the foundation for the company's success.

The Bioremediation Bugs That Never Got a Chance

Celgene's second unanticipated major setback, also almost two decades past, came about after it developed a hungry microbe that loved to dine on PCBs, those highly toxic, carcinogenic, illness-causing, poly-chlorinated biphenyl chemicals that were the unwanted byproducts of certain chemical and industrial processes. Celgene's plan was to become a leader in bio-remediation and to have its helpful microbes begin by digesting the 1.3 million pounds of PCBs that GE had dumped into the Hudson River from its capacitor manufacturing plant in Hudson Falls, N.Y., and which then -- and still do -- lie partially buried in a 40-mile plume of silt downstream from the plant. Celgene proposed that, without expensive dredging, and without unduly disturbing the underwater environment, where millions of fish spawned, its beneficial bugs be employed to eradicate the problem. It was counting on the Clinton administration to appropriate hundreds of millions for the cleanup, but that didn't happen, and the company again lingered at death's door.

Celgene learned a lot from these two near-death experiences: Don't count of big pharmaceutical companies for help. Don't depend on the government either. Don't blithely assume that certain events will come to pass, especially if those events are critical to the future of the company. Count on yourself, eliminate as many uncertainties as humanly possible, and use your special chemical and biotechnical expertise to develop and sell break-through products that very sick people needed. And that has been the miraculous Celgene story ever since, an amazing story that has taken the stock from one dollar a share on Dec. 7, 1998, to $127 today, and heading higher.

Celgene's Stumble With Second Cancers

The third major unanticipated problem that hit the company surfaced in December 2010 at the annual meeting of the prestigious American Society of Hematology, the academy of Celgene's primary customers (doctors who treat diseases of the blood), and it was not the result of anything that Celgene overlooked or failed to consider. Celgene, like many growth-oriented companies, had been planning and pushing for its products to be used more widely and for longer amounts of time. In this endeavor, it was promoting its lead product, Revlimid, for "maintenance therapy" in some forms of blood cancer. Simply put, maintenance therapy means that after the patient has been treated, and the signs of cancer are no longer detectable, the oncologist does not terminate the treatment, but continues it in order to prevent or retard the recurrence of the cancer. If this strategy proved successful, Celgene could easily, and legitimately, sell many years more of its product to each patient.

What no one at Celgene, or in the entire medical community, considered, because it was virtually unheard of, was that the long-term usage of Revlimid itself might cause cancer. But that is exactly what seemed to emerge from the statistical analysis of three clinical trials of long-term Revlimid use. which found more cases of new and different types of primary second malignancies among the patients enrolled in the Revlimid arm of the trial than those given the placebo. Although no causative effect was ever proven, the data did reveal that a certain small, but statistically significant, portion of the patients given Revlimid in the trial developed a second type of cancer. It might have been a coincidence, or a quirk in the patient enrollment, but it was a staggeringly unexpected body blow to CELG, and one that had been impossible to predict.

The stock dropped from $60 to $50, Celgene that January pulled back its application in Europe for the wider use of Revlimid. The stock did not manage to get comfortably back to $60 until the end of November 2011, almost a full year of lost momentum.

Celgene subsequently conducted an in-depth data analysis that it claimed showed no higher-than-expected number of new malignancies, while other studies showed that the increased incidence was small (2% vs. 1%). Other studies attributed the higher incidence of second cancers to the melphalan that had been used in combination with Revlimid in the studies. Today, the website for the Multiple Myeloma Research Foundation exonerates Revlimid and declares that, in an analysis of nine other studies, there are "no additional second cancers … where melphalan was not part of the treatment." Nevertheless, the incident created a dark cloud that was not easily dispersed.

Highly Reliable Earnings Projections

Based on this history of CELG having only one serious stumble in the past decade, I feel totally comfortable that, before Celgene management offers an earnings prediction, it has carefully considered just about every possibility of what could go wrong and figured that into its projections. If you accept this as a reasonable position, then let's approach the company's prediction for earnings in 2017 as if they are a done deal. But let's be conservative and work with the low end of the projection, $13 a share.

Next, let's apply to those earnings a reasonable multiple. This is the key judgment call in the analysis, and there is much information available to help. For a start, if we look at the current P/E of the four big-cap biotechs -- Amgen, Biogen, Celgene, and Gilead Sciences -- their average P/E today, based on trailing earnings, is right at 30. CELG has, in the past decade, never had a long-lasting P/E below 20 except during a concerted bear raid, and has had P/Es over 80 for long periods. Today its P/E is about 35 based on trailing earnings, and 23 based on estimated 2013 earnings of $5.50.

Although this is hardly an exact science, I don't think we can go far wrong if we grant Celgene a general P/E ratio of 25. This would also be consistent with its rate of growth, which has averaged over 25% for more than a decade and which CEO Hugin stated would continue at 25% a year into 2017, thus keeping its PEG ratio below 1 -- well into safe territory. Thompson Reuters currently forecasts that CELG will have a fiv-year expected PEG of .99, a strong indicator that the price of the stock has not outpaced the company's earnings.

If we take the $13 earnings projection for 2017 and multiply it by 25, we arrive at a reasonable price by the middle of 2017 of $325 a share. Again, to be conservative, let's knock that down more than 20%, because it's impossible to predict now whether Celgene, going forward after 2017, will be able to sustain its stellar growth rate far into the future from what will be a much bigger base.

Any severe downside risk is mitigated by many factors, including the continuing strong expansion of its proven products into new areas of illness; the company's $600,000,000 stock repurchase program; its membership in the S&P 500 and the elite Nasdaq 100, which guarantees its purchase by index-tracking funds; its strong technical profile, whereby it almost never drops below its 100-day moving average and has held strong this year above its 50-day moving average; and the fact that the shorts have finally realized their mistake of many years and have given up their efforts to beat down the stock, efforts that had stalled its momentum in 2011. In all, and erring way on the conservative side, let's accept a base price per share (PPS) of at least $250 by the end of June 2017, double its present price.

From all we know about CELG'S approved products, ongoing clinical trials, promotional skill, operations, and ability to execute successfully, it can safely be assumed that revenue and earnings will grow relatively smoothly, on an annual basis, over the next five years, with revenues increasing from $5.12 billion to $12 billion, and earnings per share keeping pace, from $5.50 in 2013 to $13 in 2017. Again using a cautious approach, let's look back to the $99 a share that CELG commanded at the end of 2012 and also assume, just to simplify the calculation, that the 2017 growth will be fully priced into the stock by the middle of that year, raising its PPS to $250 by that June. Yes, it's a crude methodology, but I think it works, and there is little logic in trying to fine-tune an estimate for five years into the future. If we deduct from $250 the $99 end-of-2012 value, that gives us an increase of 150% over five years. Dividing that increase into five equal segments of $30 each gives us, in the left-hand column, very reasonable targets with more aggressive targets (that assume a P/E of 25) in the right-hand column:

June 30, 2013

$130

$145

June 30, 2014

$160

$190

June 30, 2015

$190

$235

June 30, 2016

$220

$280

June 30, 2017

$250

$325

Click to enlarge

Using this as a template, it becomes easy for the investor to determine, as time goes by, whether Celgene has gotten ahead of itself, although any price that is even 30% above these conservative estimates would be reasonable. At today's price of $127, it seems to me right on track to be in the $130-$145 range by the end of this June, and to be at least another $30 to $45 above that by each June thereafter.

In the graph below, I've inserted the dates from Dec. 31, 1012, to Dec. 31, 2017, on the horizontal axis and the dollar prices per share from 100 to 500 on the vertical sides. I drew two straight lines on the graph, one rising from 100 on Dec. 31, 2012, to 250 on June 30, 2017, and to other rising from 100 on Dec. 31, 2012, to 325 on June 30, 2017. As long as your shares on any given day are not really far outside the "cone of comfort" created by the two lines, I believe you have no cause for concern, especially as I've applied a fairly conservative P/E to each line. I believe Celgene deserves to be close to the upper line and that a long investor should relax and not become worried if it is a little above it. If the PPS goes way above the upper line of the cone absent important bullish news, as it has done for the past month, an anxious, conservative investor might consider selling the stock or a protective covered call until it is back in the comfort cone, If the PPS drops outside the cone on the low side, except during a major market correction, you should check the latest news stories about CELG to see if there is any valid reason for this lagging performance, and be guided accordingly.

Call me simple-minded, or unscientific, or overly reliant on management projections, or whatever you want, but remember that I have slept comfortably at night for many years with this stock, and happily watched it reward me more than 180 times over! And I do, very confidently, expect it to more than double in the next five years.

What Are the Risks With CELG?

After reading this rave review, the ever-vigilant editorial team at Seeking Alpha, seeking to maintain some fairness and balance, has asked me to set forth the downside risks in buying or owning Celgene, even though I believe it is about the most risk-free growth stock in the market, and that unless Kim Jung Il decides to target Summit New Jersey, where CELG is headquartered, nothing is likely to interfere with its stellar earnings growth.

Be that as it may, I consider the most important downside risks to be these:

General market correction or decline. Far from being impervious to these declines, CELG often gets hit harder than the overall market. For example, on April 18 at 3:00pm, the Dow was down .57% and the Nasdaq was down 1.17%, but CELG has been hit a hard 2.26%, and I have seen this happen often. I have never exactly understood the logic, if any, behind this phenomenon on this solid growth stock and can only attribute it to CELG's energetic volatility. (The same, fortunately, holds true on the upside: At the close on April 22 the Dow was up a miniscule .14%, the S&P managed a respectable.47%, and the Nasdaq was roaring along at a gain of .86%. Celgene? Up 3.66%.)

Austerity constraints in the eurozone. Celgene aims to earn about half its revenues from the eurozone. Any austerity measures there that cut into the medical reimbursement programs would diminish those earnings. These programs have been sacrosanct until now because Europe places such a high value on universal healthcare, but if the axe has to bite more broadly, the prices for Celgene's drugs, some of which cost more than $100,000 a year, will get whacked.

Currency conversion issues. Since CELG earns so much of its revenue abroad, any decline in the value of the purchasing currency will go right to its bottom line, unless hedged, and negatively impact is profits.

Cuts in Medicare spending. As we all are only too well aware, Congress and the president have yet to agree on how to cut the deficit, and while the President has done his utmost to keep cuts in Medicare off the table, and to protect most entitlement programs, the day may come when they will be cut. And if they are cut, it would not be unreasonable to assume that those cuts many fall on products like Revlimid, Celgene's biggest-dollar drug, which costs between $70,000 and $100,000 a year and has profit margins as high as .80%. I have been told by one of my brokers that this should not be a concern because most of the patients treated for MM are younger than the age at which Medicare kicks in. I have no independent knowledge of this, but when I visited the chat room of The Myeloma Beacon recently and randomly checked on 10 chatters, their ages ranged from 24 to 60, with most clustered in their 50s.

Apremilast. From the data I've seen, I'm of the opinion that this oral drug demonstrated sufficient, albeit not outstanding, efficacy against psoriasis in its recently concluded clinical trial to win FDA approval after the company files its NDA later this year, but you never can be sure.

Front-line approval for Revlimid. This blockbuster is now approved for treating MM in those patients who have failed at least one prior therapy. If it can win approval for use as the first line of attack against the disease, it would greatly increase revenue, but this will depend on the results of clinical trials.

Reimbursement policy in Europe. In the U.S, once a drug has been certified as safe for use and approved for sale by the FDA for a specific indication, it can also be prescribed by physicians for other diseases, in what is known as "off label" use, and the insurance companies and Medicare will usually reimburse the patient for these charges. But it does not work that way in Europe, where patients are only covered for on-label use. This means that Celgene will have to apply there for use of its products in more illnesses and indications, and no approvals are guaranteed.

Competitive products. Several dozen biotech and pharmaceutical companies are working on treatments and cures for the same diseases targeted by Celgene's products, and if any of these prove far superior, that would certainly undercut CELG's prospects for that illness.

Failure of CELG's new drugs to sell. If some of its four newly approved drugs fail to achieve great success, this obviously adversely impacts the company's bottom line.

Nevertheless, I firmly believe, based on my long experience with the company, that all this has been considered and accounted for when it offered its guidance. Celgene has proven to be a company that anticipates all such factors and carefully weighs almost every conceivable likelihood before its issues earnings guidance or makes strategic decisions, which is why I believe we can rely on that guidance.

Although we all should know, and have often been warned, that past performance is no guarantee of future results, that axiom is not applicable here, because we are concerned, in this analysis, not with the performance of a commodity, product, or service, but with the personal performance of the men and women who run Celgene, in such vital areas as keeping their word, being conservative and realistic in their predictions, and being honest and transparent about the company's products and prospects. In those circumstances, the past performance of management is the best guide to future reliability. People do not change their character easily, as we all know from experience with our spouses, friends, and co-workers. So if we can count on the character of Celgene management, and I strongly believe we can, then we can assuredly count on $250 a share or more by the middle of 2017. Probably even $325. Or, if you use the high end of their earnings prediction, at $14, and apply a not-unreasonable P/E of 30, then -- hold your breath -- $420!

Disclosure: I am long CELG. 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.