Back in January Goldman Sachs (NYSE:GS) panned Celgene (NASDAQ:CELG), downgrading the company to a "Sell." Perhaps analysts, or strategists, knew that investor psychology would make biotechnology stocks that ran up in 2013 vulnerable to almost any sort of questioning campaign. Celgene's 52-week high had been $174.66 on January 13, 2014. Following that Celgene's low was $135.60 on April 11, and nothing guarantees the selloff may not resume.
But as a long-term investor, I know that the real value of a company depends on what earnings it achieves in 2014, 2015 and beyond. My analysis is that earnings will grow substantially. The best use of mistaken investor psychology (if you hold for the long term) and sell-side analyst manipulations is to buy when psychology is unduly negative (and sell into unjustified ebullience).
As always, the truth resides in the fundamentals. At pharmaceutical companies' fundamentals have their foundation in future sales of currently approved therapies and in pipelines. There were quite a few developments at Celgene in the last 12 months that affect these foundations. Revenue from sales of its key current drug, Revlimid for multiple myeloma (MM), increased 14% (Q1/Q1), while long-awaited filings to extend the label to newly-diagnosed MM were made in the U.S. and Europe.
Abraxane was approved for pancreatic cancer, in addition to its earlier approval for breast cancer. Pomalyst, an oral therapy, was approved for MM and sales have ramped quicker than expected, to $135 million in Q1. This is despite having competition from Amgen's (NASDAQ:AMGN) oral MM therapy, Kyprolis, which generated $68 million in sales in Q1.
Apremilast turned in good data for psoriasis and related diseases in 2013. Its market name will be Otezla, and FDA approval was given on March 21, for psoriatic arthritis, so we will see first revenue in Q2. Celgene expects Otezla sales to reach $1.5 billion, or perhaps as high as $2 billion, in 2017. Given the many rivals in the psoriasis market, it will be interesting to see if Otezla's market share reaches Celgene's projections.
On January 13, Celgene released 2014, 2015 and 2017 guidance. On April 24, Celgene released Q1 2014 results and confirmed full 2014 guidance. Short-term investors will want to focus on the Q1 results and 2014 estimates. Short term, I'll just note that Celgene has a high P/E (price to earnings) ratio; maintaining it requires investor confidence in a high rate of profit growth. However, that P/E is well down from its January peak.
As a long-term investor, my deepest interest is in where Celgene stock could reasonably be at the end of 2017. The easy answer comes from not doubting any of the parts, but accepting Celgene's 2017 estimate. Celgene projects revenues of $11.5 to $12.5 billion in 2017, up from $6.5 billion in 2013. Given operating margin estimates, the resulting non-GAAP EPS is expected to be in the vicinity of $15.00, compared to near $6.00 in 2013.
But what will the P/E ratio be in 2017? That depends on growth prospects when we get there. The trailing non-GAAP P/E on April 28, 2014 is 22.8. Note that using GAAP earnings, the current trailing P/E was 45.
Using 23 as a multiplier and $15.00 in earnings, the price at the end of 2017 would be $345 per share. Sure, there will be some companies that appreciate faster between now and the end of 2017. If you can pick them now, go ahead. You can also get any target price you want by varying your P/E assumptions, but if Celgene's growth prospects beyond 2017 look as good as its growth prospects to 2017, if anything a higher P/E could be justified.
In looking out four years to 2017, we do need to recognize that a lot of things could go wrong. Private insurers or government health plans (particularly outside the U.S.) could demand lower prices for therapies. A new competing therapy could come to market and take market share. An unexpected adverse reaction to a therapy could be discovered. Or operating costs might exceed estimates, lowering profits. Cash could be spent on acquiring drug candidates, or entire companies, that turn out to be failures.
Being aware of all that, I also note that the picture could be even rosier than outlined by Celgene management. As far as I can tell, the 2017 figures do not include any revenues from the pipeline except for Otezla. It is worth taking a brief look at the pipeline (excluding expanding current therapies to new targets or broader labels):
For lymphomas, there is the Btk inhibitor CC-292 in Phase I; it is also in Phase I trials for Chronic Lymphocytic Leukemia. Sotatercept is in Phase II trials for a variety of anemias. CC-122, CC-115, CC-122 and CC-486 are in Phase I trials for solid tumors. In the anti-inflammatory segment, we have CC-11050 in Phase II for cutaneous lupus erythematosus and CC-220 for undisclosed targets in Phase I. For Crohn's disease Celgene has PDA-001 in Phase I. Last on my list, a cellular therapy for organ transplants, UCB + HPDSC is in Phase I.
So, at least balancing the possibility that Celgene will not hit its 2017 estimates, there is the possibility that one or more of these earlier-stage therapies will gain FDA approval and begin generating significant revenue, or at least foreseeable revenue, before the end of 2017. Celgene also can buy or generate (internally or with partners) new potential therapies, or advanced preclinical candidates to human trials; for example GED-0301, discussed in more detail below.
In conclusion, while there are risks involved, I see no reason I should not hold my Celgene stock until at least 2017, when my expected value would be $345 per share. I also see no impediment to long-term investors buying at current prices, if there is money to invest and something better cannot be found.
Full year guidance for 2014 is non-GAAP EPS of $7.00 to $7.20. Using a multiplier of 23, I would expect the stock to be at least $160 per share when results are reported for 2014, and reach $200 per share some time in 2015 (based on Celgene's estimated 26% CAGR for EPS growth through 2017). Of course, I will change my projections as facts present themselves. Competition, unexpected adverse reactions to approved drugs, and failure to execute are always possible in the future. Also, it would not be surprising for the non-GAAP P/E to rise, given the future profit stream.
Cash, however, is not a plus. At the end of Q1 Celgene held cash and equivalents of $5.1 billion, as opposed to short and long-term debt totaling $5.3 billion, so about cash neutral. Cash flow from operations was $557 million. Celgene has been buying back stock, $1.66 billion in Q1. The board also authorized an additional $4 billion in share repurchases. I don't like the debt, but I agree with the board that looking to the future, reducing the share count and increasing future EPS is one good use of cash. I'd like to see a dividend paid, which would attract a different class of investors to the stock, but there is no indication Celgene's board is seriously considering that.
Finally, on April 24, Celgene announced a major license agreement with Nogra Pharma Limited to develop and commercialize GED-0301, an oral antisense DNA oligonucleotide with Smad7 mRNA as a target for treating Crohn's disease and related indications. A Phase II trial was completed and data will be presented at an upcoming medical meeting. Upfront payment will be $710 million, plus development milestone payments that could reach $815 million for multiple indications, and sales milestones of up to $1.05 billion if annual sales reach $4 billion. Since I have not seen the Phase II data, I'm not in a position to pass judgment on the deal, but clearly it presents a major opportunity, with the main risk being that something negative will come up in the Phase III trials that is not yet anticipated.
I bought my CELG mostly in 2007 and 2008, sold some once because it rose fast enough to exceed my portfolio limits on a single stock, and recently have been buying again.
I hope sharing my thoughts will help other long-term investors with their thinking about Celgene. As to short termers, what they do seldom affects the long run. But I thank them for providing liquidity and an air of excitement to investing in stocks.
Disclosure: I am long AMGN, 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.
Additional disclosure: I last added to my long CELG position on April 24.