I tend to shy away from stocks that are high on momentum and carry high P/E (price to earnings) ratios. A flattening of revenue or profit growth can lead to P/E reductions that bring big losses, at least short-term, to investors. Yet occasionally a P/E can seem high, but the stock price still does not begin to reflect the long-term profit potential of the company. In looking at the biotechnology companies in the Nasdaq 100, I believe that Regeneron Pharmaceuticals (REGN) is such a stock. Of course there are caveats, which I will discuss.
Regeneron currently has one big money maker, Eylea (aflibercept), which is currently used to treat wet AMD (Macular Degeneration), a disease that can lead to blindness. Eylea was approved by the FDA in late 2011. In Q2 2013 Regeneron reported revenue of $330 million from Eylea sales. Eylea is a large protein molecule (biologic), monoclonal antibody that works by inhibiting vascular endothelial growth factor (VEGF), which can cause excessive blood vessel growth. In the AMD market it competes mainly with Lucentis. Both drugs are injected into the eye. Since Eylea works well when injected into the eye less often, every 1.7 months vs. 1 month for Lucentis, it has tended to gain market share since its introduction. The other competitor is Avastin, which has not been approved by the FDA for AMD (but it is approved for treating a variety of cancers). However, Avastin is a VEGF inhibitor, it works, and it is much cheaper.
Looking at the usual factors in Regeneron's stock price (September 6, 2013 close of $267.57), Q2 total revenue was $457.6 million, up 50% from $304.4 million in Q2 2012. GAAP diluted Earnings Per Share (EPS) was $0.79, up 13% from $0.70 year-earlier. Non-GAAP EPS was $1.73 per share, down sequentially from $1.78, but up 92% from $0.90 per diluted share year-earlier.
That is pretty astonishing y/y growth, but it comes from the usual nature of the ramping a new drug in by a company that had little or no prior revenue. The growth rate could justify a high P/E, but only if the revenue and profit ramp will continue. Regeneron's trailing non-GAAP P/E is 35.7 (a rule of thumb is any P/E above 20 indicates expectations of at least moderate profit growth; there are formulas that give exact numbers, but they rely on assumptions about the average rate of return on investments and guesses about future profits, so good rules of thumb are more practical). GAAP trailing earnings are $4.63, so trailing GAAP P/E is 57.8, even higher.
On the negative side, after hitting $1.72 in Q3 2012, GAAP EPS has dropped sequentially each quarter. Non-GAAP EPS was $2.29 in Q3 2012, so it has also been declining, but more gradually. Usually companies with stocks with a history of decline have P/Es of 15 or under. Revenue was $428 million, which means the sequential increase from Q2 2012 to Q3 2012 brought most of the revenue growth in the last year. The main reason for the declining earnings despite rising revenue is in expenses, which were (GAAP) $225 million in Q3 2012 but had risen to almost $300 million in Q2 2013. In particular, R&D expense rose $29 million and SG&A (administration) expenses rose $25.6 million.
But here the difference between the short term and the long term makes a big difference. To optimize short term profits Regeneron would have cut the R&D budget to as close to zero as possible. To optimize long term profits more drugs have to be developed, and even Eylea needed to get approved by the FDA for indications other than AMD.
Future Eylea revenue alone might justify the extraordinarily high P/E because it has just begun its international expansion. The pipeline of other drugs, of course, should be treated with a reasonable degree of caution. Not every drug will be approved by the FDA, and of approved drugs some may not sell well due to competition.
Eylea is a pipeline unto itself. Improperly regulated VEGF, it turns out, plays a role in a number of diseases, including solid cancers, where growth is dependent on the formation of new blood vessels (recall Avastin, a cancer therapy, has the same mode of action). A second eye-related indication, CRVO (Macular Edema following Central Retinal Vein Occlusion), was approved by the FDA in September 2012, where again its chief rival is Lucentis, and was approved in Europe on August 29. A variation on Eylea, ziv-aflibercet or Zaltrap, was approved in August 2012 for second-line colorectal cancer in a collaboration with Sanofi (SNY). There are also European approvals for these indications. On August 6 positive Phase III data for Eylea for diabetic macular edema (DME) was reported and Regeneron is planning to submit the drug to the FDA for approval later this year. That means a likely new revenue ramp in the second half of 2014, as DME is a problem for well over one-half million Americans, and can become a problem for any of the 25 million Americans with diabetes.
Finally, Eylea is also in Phase III trials for Macular Edema following Branch Retinal Vein Occlusion. Also in Phase III and looking likely is Sarilumab for rheumatoid arthritis, which if approved could have a very large addressable market, but will be in competition with a large number of therapies including older generics. Alirocumab (PCSK9 Antibody) for lowering cholesterol (LDL, the bad kind) is also in Phase III. While it is entering a crowded market, it can be administered (if approved) at two-week or even one-month intervals.
In Phase II we have Dupilumab (IL-4R) antibody for eosinophilic asthma and atopic dermatitis; it reported positive Phase IIa data in May. Fasinumab (NGF Antibody) for pain from osteoarthritis has been on clinical hold since in late 2010, but not because of anything seen in its trial. Another company's anti-NGF therapy has a serious adverse event, so all anti-NGF trials are on hold until the issue is sorted out. [This is the type of thing that can come up even after FDA approval, which is why I like to use conservative probabilities to calculate future values of pipeline candidates.]
Regeneron has 8 monoclonal antibodies in Phase 1 (safety trials), mainly targeted at advanced metastatic cancers.
One early stage candidate was pulled from development recently for not meeting expectations. Probably the single most valuable asset of Regeneron, in the long run, is its ability to generate a practically unlimited series of monoclonal antibodies in house which can be put into the pipeline. Of course all of this requires R&D dollars, so it will happen gradually. Management, as a result, does not have to hang onto marginal candidates that may flop in Phase II or Phase III. Regeneron can kill a marginal candidate in pre-clinical or Phase I trials, saving the company a lot of money that would be wasted if a therapy failed to reach commercialization.
In short, long-term Regeneron looks like a biotechnology gold mine. It looks to me like it will be worth tens of billions in market capitalization over the next decade. (Current market capitalization is $26.4 billion.)
So the various analysts and others who have been hyping Regeneron, as far as I can tell, are right. That does not mean the stock will go up in a straight line. Its high P/E indicates somewhere between a year and two years of EPS growth are already priced into the stock. A number of factors could depress the price in the short run: failure or delay of a therapy that is expected to get FDA approval; pricing pressures; increased competition resulting in lost market share; a general decline in the stock market, or just profit-taking by investors who got into REGN early and want to spend some of their gains.
I don't see, however, a significant likelihood that Regeneron will be under $300 per share two years from now. More likely, with new revenue and profits, and with a pipelines where candidates are continuing to progress, any decrease in the P/E would be more than compensated for by increased earnings.
I don't think it is a good idea for me to put out a specific number for, say 2016 EPS or a stock target, given the many events and likely variances (including, particularly, pricing of new therapies) ahead. However, I would buy Regeneron today, with good (but of course not 100%) confidence that it will be one of the stocks that will have me and a lot of investors far richer by, say 2020. Most people can't think that far ahead, which is why the stock is bargain-priced today.
However, I said I would not make this new biotech investment round without going through the full process and sharing it with my readers and friends. Next up, the last of my Nasdaq 100 biotechnology checklist companies, Vertex Pharmaceuticals (VRTX). After that I will research and write about perhaps 10 to 15 smaller companies before wrapping up this round.