- Biogen Idec sold off last week on Federal Reserve concerns about valuation in smaller biotechs.
- This large company generates large amounts of cash, despite spending heavily on R&D.
- This article explains why I look at Biogen Idec as a core holding within the biotech universe.
Background: Biogen Idec (NASDAQ:BIIB) stock has taken a tumble following comments out of the Federal Reserve about smaller biotech stocks. The stock fell from over $320 to under $300 on no other news.
This looks to me like a buy-the-dip opportunity for patient investors, and seasonal weakness and other factors such as high current P/E may allow investors to get in cheaper. But for growth investors, I like this company, and while it is not cheap, I always try to keep Warren Buffett's saying in mind to the effect that the important thing is to find great companies at fair prices rather than trying to find average companies at great prices. I put BIIB in the great company status. Here's my capsule analysis of BIIB.
Note that BIIB releases earnings July 23. Because of the recent sell-off, I am writing this now, as the company has a fairly good record of beating expectations.
Introduction: There are a small number of icons in my firmament of top medical/pharmaceutical companies, and BIIB comprises two of them. It was formed by a 2003 merger, with Idec the surviving entity. The headquarters are, however, in Biogen's area in Cambridge, Mass. Biogen was one of the very earliest biotech companies; its history, from founding in 1978 to 2000, is interesting and shows the difficulty in succeeding as a pioneer in a brand new field. Biogen's major product was Avonex, for multiple sclerosis, which is now felt to be an autoimmune disease. Idec's first and major marketed product was the cancer and autoimmune treatment, Rituxan. Both these biotech, injectable products remain mainstays for the company, but are not growing much any longer. Given the similar research focus of Idec and Biogen, this merger is one that made sense from the start. The company is going from strength to strength now, as the stock chart suggests:
Splits: Dec 21, 1999 [2:1], Jan 18, 2001 [3:1]
(I assume that since Idec was the acquirer, the pre-2003 part of the chart is of it.) Since the merger on 11/11/2003, BIIB has returned about 21% compounded per year, trouncing the broad averages. Sales and earnings have moved along with the stock price. In the company's first full year, 2004, there were 335 million shares outstanding; sales per share were $6.60. Profits were nominal at 7 cents, rising to 47 cents in 2005 (all data are per share, where relevant). We are now looking at a projected share count of only 236 million and adjusted cash EPS of $11.50 for 2014. Sales per share have grown 25% per year over the past decade to a projected about $9 billion this year. Simply from 2011 to 2014, EPS will have grown from $5.04 to $11.50 (projected).
BIIB is one of those stocks that spends so much on R&D that standard P/E measurements are not fully relevant.
BIIB is currently trading at slightly more than 21X projected 2015 non-GAAP earnings. It has a long history of exceeding expectations.
BIIB's product lines and research foci:
A. Multiple sclerosis. BIIB dominates this field, an impressive achievement.
1. It has a cash cow in Avonex, and continues to improve the product by improving the mode of administration.
2. Its Tysabri is a more powerful and more dangerous injectable treatment for MS, and is being tested for a less common form of the disease; thus, it has substantial growth potential (it is also being tested for stroke).
3. Most timely right now are the booming sales of a twice-daily oral treatment for MS, Tecfidera. This is competing well with the Novartis (NYSE:NVS) oral once-daily MS pill Gilenya, which may have more side effects than Tecfidera. Both are very effective, and are part of an evolving paradigm toward oral treatment in autoimmune diseases (and also in certain malignancies).
4. A long-acting version of Avonex, called Plegridy, is awaiting approval in both the U.S. and the EU. This is as effective as Avonex, apparently, but only needs to be administered once every two weeks, rather than once a week as Avonex typically is given. Side effects differ; over time, I anticipate that having both products available will enhance BIIB's sales and profits.
5. Another marketed product for MS, Fampyra, and daclizumab in the pipeline join Tysabri's Phase 3 trial for secondary-progressive MS in the MS roster.
In Q1, the MS franchise accounted for $1.7B in sales, up 41% yoy, driven by the extremely successful introduction of Tecfidera, but with growth in all important product lines.
B. Other neuro: BIIB's pipeline, along with its marketed products, is shown on its website, and one can see there are a number of neuro drugs in different stages of testing. Some, such as anti-LINGO, are specifically for MS; others such as Neublastin for neuropathic pain might be for MS patients, among other types of patients. Alzheimer's disease is somewhat of a focus now.
C. Oncology: Idec invented Rituxan; it now partners with Genentech (a Roche subsidiary) on it. Rituxan is a standard of care for certain B-cell malignancies. It is also approved for certain non-malignant, autoimmune conditions, such as rheumatoid arthritis. Recently, a follow-on monoclonal antibody for similar oncologic uses, Gazyva, was approved in a joint development program with Roche. Royalty income from Rituxan plus Gazyva in Q1 was $297 MM. This was up 12% yoy, but the underlying trend may not be so favorable to BIIB. It's not clear to me how much profit share BIIB is receiving and will receive from Gazyva; my guess is that it is less than from Rituxan. I do not look at this franchise as much of a growth driver until proven so.
D. Hematology: Alprolix for hemophilia B and Eloctate for hemophilia A (which is more common) represent a potentially important set of orphan drug products for which marketing is just beginning. The advantage of each product over existing treatments is longer duration of action, which means that fewer infusions will be needed. Competition is probably coming, but as of now, BIIB has a chance to seize the lead in this valuable, chronic market. The company has estimated these products address a $7 billion annual market.
E. Immunology: The company has a broad set of drug candidates and research focus for autoimmune disease, as well as fibrosis and other types of disease such as tissue injury that it classes under its immunology program.
In addition, BIIB has a preclinical-stage agreement with Sangamo Biosciences to develop treatments for sickle cell disease and at least one other hemoglobin disease. Furthermore, the company is going to enter the biosimilar business, which is a move that its peer Amgen (NASDAQ:AMGN) is also making.
Financial results and valuation: As was discussed above, BIIB has been a high-growth company. Current projections are for growth to about $14.50 EPS in 2015 on $10+ billion in sales. Cash flow per share in that scenario would be close to $19/share, leaving at least $17 in free cash flow per share. With the stock currently at $304, it is trading at a projected 18X 2014 FCF. That translates to a 5.5% FCF yield.
I find this very attractive. I think back to growth stocks in the '90s, with higher P/Es, lower P/E/Gs, and much more attractive cash or bond alternatives to compete for my money.
I like to take the long view for a company such as Biogen Idec that is a leader in industries of the future, as biotechnology appears to be. Let us assume that the future has some bumps, competition and research failures slow it down a lot, and EPS and FCF only grow at a compound rate of 7% per year from 2015 through 2025. (I think it will grow faster than that.) Simple arithmetic suggests that this will be equivalent on an FCF basis to owning a bond with an average yield of about 8%, with yet higher yields based on today's stock price expected beyond 2025. Of course, BIIB shareholders are looking forward to much faster growth than 7%.
R&D expense was $1.4 B in 2013, about 20% of 2013 revenues.
Also, BIIB is running 25% or so tax rates. As we know, either by being taken over by a foreign company with a low corporate tax rate or through an inversion, this rate could go lower.
Independent valuations: S&P Capital IQ has a 12-month price projection of $324 and a separate fair value estimate of $355. Thomson Reuters rates it 8/10, Verus at 7/10.
Of the indies that Fidelity provides access to, all have BIIB either as a buy, outperform, or neutral. Jefferson Research rates BIIB as "strongest" on all its four categories except valuation. Those four categories are earnings quality, cash flow quality, operating efficiency, and balance sheet. It rates BIIB's valuation as "highest risk." This is similar to my assessment, though I do not think that BIIB's valuation is as challenged as Jefferson does. I do think that its operations are both scientifically and financially very strong.
Technicals: My view is that the chart is strong enough to allow the stock to be bought here. As occurred this spring, BIIB sold off last week and bounced off of its rising 150-day EMA. The 50-, 150- and 200-day EMA are in bullish alignment to each other and are rising. I generally ignore MACD, RSI etc., so I'm not going to comment on them. Over 35 years of buying stocks, I have not found them useful, but I'm sure there are people who make great use of them.
The long-term chart pattern is a strong bottom left-to-top right pattern characteristic of great growth companies.
Risk: BIIB has a beta of 0.90. It receives an "A" for financial strength from Value Line, but S&P Capital IQ considers it a high-risk stock. It may not move all that much with the market, but as we saw last week, it can move plenty fast on little news. The company has operational, research, and competitive risk. Reduction in the market's overall P/E may affect its P/E, even if prospects are unchanged. Adverse developments with biosimilars will hurt it (though it plans to compete in that field as a biosimilar producer).
The stock has moved a lot in the past 4-5 years, and its P/E on current year consensus EPS is above 25X. Thus, even though BIIB is well off its $358 high in time and price, it is not cheap and could well trade lower, simply as Mr. Market moves its price around for whatever reason he wants, or no identifiable reason at all.
Of course, the company provides a long list of risks in its SEC filings. Nothing herein is intended to substitute for those disclosures.
Conclusion: Biogen Idec is a research-driven powerhouse that is a strong free cash flow generator. It has a variety of growth drivers, strong finances, and some diversity in its product lines. It dominates the drug treatment of an important and devastating disease, multiple sclerosis. BIIB trades at a high multiple of historical and current-year earnings.
I own the stock for long-term appreciation, but do not believe that it is on the bargain counter. If I were still a seller of puts, this is one stock where I would consider selling a put at or below the market several to six months out. However, I am bullish on BIIB and bullish on biotech, and consider BIIB a core, relatively safe holding in the biotech universe. Thus, I am simply long the stock and would hope that if it drops not because of any important fundamental reason, I will have the ability to purchase more.
Additional disclosure: Not investment advice. I am not an investment adviser.