An Analysis Of Amgen

Aug.22.14 | About: Amgen Inc. (AMGN)

Summary

Amgen has a balanced mix of mature blockbusters, new products and a diverse pipeline.

Despite more than doubling in the past few years, its absolute and relative valuation metrics could increase further.

The turnaround in R&D and a new focus on marketing could allow it to grow profits rapidly in the next several years, giving the stock very large upside potential.

Background: The story of Amgen's (NASDAQ:AMGN) first success was that it got lucky: It was seeking funding for its initial product candidates, and the money people insisted that it add one additional drug to the several that Amgen had listed. It did, and that add-on was the only success of the bunch, a replacement a medically obscure hormone called erythropoietin in renal failure (dialysis) patients, whose kidneys were no longer making enough of this red blood cell stimulator. Lo and behold, Epogen made Amgen a powerhouse.

AMGN has been public exactly 30 years. Its compound annual return is a truly unbelievable 27%.

After Epogen came the next blockbuster, the white blood cell stimulator Neupogen (filgrastim). And then the important innovation stopped - until recently. Erythropoietin (now called epoetin alfa) got a longer-lasting version, darbepoetin, called Aranesp. And Neupogen was enhanced with a pegylated (longer-acting) version, logically named Neulasta. Fine though new products were, highly innovative they were not.

It was apparent by the time these four products were out that AMGN was becoming a bubble stock in the late '90s. Those of us in the industry saw them unfortunately having trouble advancing new molecules through to FDA approval. Here is the stock chart:

Click to enlarge

Splits: Aug 13, 1990 [2:1], Sep 11, 1991 [3:1], Aug 16, 1995 [2:1], Mar 1, 1999 [2:1], Nov 22, 1999 [2:1]

After hitting the mid-$70s, the stock peaked as internal R&D brought forward no new products. A needy Amgen bought Immunex in 2002 to gain Enbrel for rheumatoid arthritis, psoriasis and other arthritides. Enbrel is now its largest seller and one of the top five products in the world. Other product acquisitions ensued, but its own R&D was viewed poorly. This accounts for AMGN's relative P/E sinking to an average of about 0.7X that of the market between 2008 and 2013, bottoming at 10.7X EPS for 2011.

Times have now changed for the better within Amgen, and AMGN may have a lot of appreciation ahead. This article assesses it using a sum-of-the-parts method, and concludes that it has a promising pipeline that could be considered to be receiving no value in the current stock valuation.

Introduction: All the above five products named, most of Amgen's more junior products, and most of its pipelines are approved not via the NDA process used for oral drug products but as biologics, via a BLA. As proteins which cannot be dosed orally but must be injected, they are not subject to direct generic competition via the traditional 505(j)-based ANDA pathway specified by the "Hatch-Waxman Act" of 1984. Instead, both in the U.S. and in Europe, a copycat version must be approved via a much more expensive route, ending up with a "biosimilar" product that requires marketing rather than simply relying on pharmacies to automatically substitute a cheaper ANDA-based generic for the brand. Europe is more advanced than the U.S. in setting biosimilar rules; the FDA has not finalized its regs in response to relatively recent legislation authorizing biosimilars here.

Life and death issues can arise from small changes in manufacturing of proteins. A close relative of Epogen called Eprex had, a number of years ago, a spate of cases of pure red blood cell aplasia that, if memory serves, were traced to a small change in manufacturing procedure. When corrected, these devastating episodes went back to a baseline incidence. A protein-based competitor to Epogen, Omontys, from Takeda (OTCPK:TKPYY) and Affymax (OTCQB:AFFY), came to market in 2012 and after killing a few people due to severe allergic reactions, was withdrawn last year. AFFY is closing its doors as a result.

Thus, having a long-lived successful true biotech product (i.e., an injectable protein) is a great thing in pharmaceuticals. The same annual cash flows translate into much higher total cash flows due to the lack of a generic equivalent. Amgen is the beneficiary of this.

Durable biotech products deserve higher P/E's than oral, small molecule-based products which will go generic and lose almost all their sales.

Supporting this view is that Amgen and other biotechs report that they have seen only mild impact from biosimilar competition, both in the U.S. and in Europe. Because of its abilities and trusted name, Amgen is planning to compete in the biosimilar field. For purposes of analysis in the rest of the article, I am therefore going to ignore biosimilar competition to Amgen's products and also ignore any future cash flows from its own biosimilars, figuring that the losses from biosimilar competition and gains from its own biosimilars will tend to balance out (though it would not be surprising if Amgen were a net gainer from this issue).

Next, let's look at AMGN shares by studying the company four ways, starting with its tangible assets.

1. Cash, assets, and debts: From its Q2 earnings report, the company's value is at least negative $4b by this parameter:

June 30,

December 31,

2014

2013

Assets

Current assets:

Cash, cash equivalents and marketable securities

$ 26,188

$ 19,401

Trade receivables, net

2,697

2,697

Inventories

2,954

3,019

Other current assets

2,489

2,250

Total current assets

34,328

27,367

Property, plant and equipment, net

5,371

5,349

Intangible assets, net

13,499

13,262

Goodwill

14,844

14,968

Restricted investments

-

3,412

Other assets

1,492

1,767

Total assets

$ 69,534

$ 66,125

Liabilities and Stockholders' Equity

Current liabilities:

Accounts payable and accrued liabilities

$ 5,366

$ 5,442

Current portion of long-term debt

2,500

2,505

Total current liabilities

7,866

7,947

Long-term debt

30,828

29,623

Other non-current liabilities

6,458

6,459

Stockholders' equity

24,382

22,096

Total liabilities and stockholders' equity

$ 69,534

$ 66,125

Shares outstanding

759

755

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Shareholders' equity of $24 B is offset by intangibles and goodwill of $28 B. (This situation comes from the vast amount of money that has been returned to shareholders, mostly from aggressive buybacks.) Most of the cash is offshore whereas I assume that most or all the debt is based in the U.S. In that case, some haircut should be given for taxes when the debt is eventually brought back to the U.S. (Presumably some cash will come back via a low-tax holiday.) An estimate of the quantities involved was reported by theweek.com, which said that Amgen would owe $9.1 B in taxes if all its foreign cash were repatriated. Specifically, it reported that:

Amgen has eight subsidiaries - three in Bermuda, one in Ireland, two in the Netherlands and two in Switzerland. It's holding about $25.5 billion offshore. That would be about a $9.1 billion tax billion (sic) in the U.S. It paid an offshore tax rate of 0 percent. (Ed.: The $9.1 B tax estimate may be too low, as I think it may well omit California taxes.)

I'll be conservative here and subtract an additional $6 B for unpaid taxes that must be paid in order for shareholders to actually receive these earnings. That puts AMGN's net worth at negative $10 B.

Of course, AMGN is really worth a great deal of money, and the rest of this article explains different ways of looking at its many positives.

Next we will look at its legacy blockbusters, the five products described in the Background section.

2. From the earnings report, here is the list of products it markets:

Product Sales Detail by Product and Geographic Region

$Millions, except percentages

Q2 '14

Q2 '13

YOY Δ

US

ROW

TOTAL

TOTAL

TOTAL

Neulasta®/ NEUPOGEN®

$1,109

$320

$1,429

$1,444

(1%)

Neulasta®

895

238

1,133

1,120

1%

NEUPOGEN®

214

82

296

324

(9%)

Enbrel®

1,171

72

1,243

1,157

7%

Aranesp®

223

294

517

524

(1%)

EPOGEN®

512

0

512

502

2%

Sensipar® / Mimpara®

204

94

298

259

15%

Vectibix®

36

96

132

93

42%

Nplate®

62

56

118

105

12%

XGEVA®/ Prolia®

366

197

563

437

29%

XGEVA®

207

92

299

249

20%

Prolia®

159

105

264

188

40%

Kyprolis®

75

3

78

0

*

Other

0

59

59

74

(20%)

Total product sales

$3,758

$1,191

$4,949

$4,595

8%

* Not meaningful

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The total sales of Neulasta/NEUPOGEN, Enbrel, Aranesp, and EPOGEN annualize around $15 B. Enbrel sales grew mostly due to a price increase, and Neupogen sales fell largely from a one-time event last year. So I am going to assume stagnant sales from these products. After the Omontys fiasco, I am not going to assume any competition to Epogen or Aranesp other than from biosimilars, which I again am leaving out of the calculation for the reason described above. The same goes for Neupogen/Neulasta.

Enbrel is going to have increased competition both from other proteins as well as oral meds such as Otezla, from Celgene (NASDAQ:CELG). So I'm considering that a no-growth product as well, and perhaps one that will not be a huge seller even in nominal dollar terms a decade from now.

How do we value these legacy blockbusters?

Since they are cash cows, I would do it on a P/E basis. Lacking knowledge of Amgen's internal costs, I'll assume a 90% gross margin and 10% of sales allocated to sales, marketing and G&A; leaving an 80% pre-tax profit margin. Subtracting about 40% for an ultimate tax burden (this might be too strict) gives a net profit margin around 50%. This suggests $7.5 B in annual profits for years to come from the $15 B in annualized sales.

Given lack of generic competition, I'm disinclined to do much discounting for present value here. Presumably prices of these products will trend up with general inflation of cost inputs. Given the wide moat that four of the five products have (Enbrel is less safe), I'll give these products a 10X multiple. This is a judgment call. Given how low interest rates are and how durable the four blood cell stimulating products are, perhaps 12X is also reasonable. Note, however, that I am inventing my profit margins, so please do not take these numbers as anything like Gospel.

Given the above caveats, I am valuing these mature products at $75 B. if, for example, a company were spun off with them as the only assets and with no R&D being performed. (This assumes the Newco did not incorporate in Ireland, in which case the tax take would decline dramatically.)

Next, I discuss Amgen's smaller, younger growth products.

3. The other products: In addition to the products shown above, Amgen received $231 MM last quarter in gross income from Onyx products (it acquired Onyx late last year). This is recorded as follows:

Condensed Consolidated Statements of Income - GAAP

(In millions, except per share data)

(Unaudited)

Three months ended

Six months ended

June 30,

June 30,

2014

2013

2014

2013

Revenues:

Product sales

$ 4,949

$ 4,595

$ 9,305

$ 8,746

Other revenues

231

84

396

171

Total revenues

5,180

4,679

9,701

8,917

Operating expenses:

Cost of sales

1,081

785

2,171

1,529

Research and development

1,018

967

2,045

1,845

Selling, general and administrative

1,136

1,256

2,159

2,414

Other

43

121

60

137

Total operating expenses

3,278

3,129

6,435

5,925

Click to enlarge

Adding all the "other" products apart from the five listed as mature blockbusters - a mixed bag, to be sure - gives roughly $6 B in annualized revenues. These are mostly but not entirely proteins that will not go generic soon if ever. Thus it may be appropriate to value them on a multiple of sales. My take is that this is not the most inspired group of products, but it is high quality and growing. I would give it 7X sales, or $42 B in value. (Other biotechs receive higher valuations.) Again, this is arbitrary but it's what I have used to decide to buy and hold AMGN for my personal account.

Adding this value with the prior gives $42 + $75 B - $10B = $107 B. This is marginally above AMGN's current market value of right around $100 B. Let's round down and say that by the above (estimated) analysis, AMGN's market cap is equal to its tangible (negative value) assets plus my rough estimate of the theoretical market value of its marketed products.

In the bad old days of low- or no-productivity out of Amgen's research lab, that would have been fine and left the stock uninteresting. Things have changed for the better at Amgen, however. So let's discuss the pipeline.

4. Amgen's pipeline and intangibles: The earnings report conveniently provides the following:

Second Quarter Product and Pipeline Update

Projected 2014 milestones for innovative pivotal programs:

Clinical Program

Lead Indication

Milestone

Timing

Evolocumab

Dyslipidemia

U.S., EU submission

Q3 2014

Ivabradine

Chronic heart failure

U.S. submission

Achieved

Kyprolis®

Multiple myeloma

Phase 3 ASPIRE interim analysis*

Phase 3 FOCUS data*

Q3 2014

Talimogene laherparepvec

Metastatic melanoma

U.S. submission

-------

EU submission

Achieved

-------

Q3 2014

Blinatumomab

Relapsed/refractory acute lymphoblastic leukemia

U.S. submission

H2 2014

Trebananib

Recurrent ovarian cancer

Phase 3 data*†

Q4 2014

Brodalumab**

Psoriasis

Phase 3 data

Achieved††,

Q4 2014

AMG 416

Secondary hyperparathyroidism

Phase 3 data

Achieved††,

Q3 2014

Click to enlarge

Below that box is a brief discussion of each of the above (not shown). Note that Kyprolis is already marketed and is thus not solely a pipeline product; both the ASPIRE interim analysis (positive) and FOCUS data (negative) have been the topic of press releases.

Several of the above products are either niche-y or follow-ons to existing products, but the cardiovascular pair that lead off the list could together be a home run with at least two men on base, perhaps even a grand slam. This is worth a brief discussion.

Ivabradine, has been filed with FDA for marketing approval. It is a very interesting drug out of Servier, a French company. It was approved in Europe in 2005 for angina. Amgen has filed for FDA approval for treatment of congestive heart failure. In most other jurisdictions, its main use is for angina. This drug acts like a beta-blocker for angina in that it slows the heart beat, but unlike beta-blockers, it does not weaken the force of contraction. We will see what FDA says, but its history in CHF use is that it can be used with or without concomitant beta-blocker therapy. On its own, ivabradine could be a significant product for a smaller company than Amgen, especially one with a cardiology focus such as Forest. However, Amgen has no CV sales force, and would not bother creating one just for ivabradine.

The potential blockbuster, and potential mega-blockbuster, is evolocumab. I intend to say more about this drug class in a separate article. It might be a giant class of LDL-lowering products. Few high-risk patients actually get to the ideal goal of 50-70 mg/dl for their LDL levels when on statins. Almost no one gets to 50, although data suggest plaque regression may occur at that level. (This is an inter-species observation, by the way.)

Evolocumab is in a race for FDA approval for the Regeneron (NASDAQ:REGN)-Sanofi (NYSE:SNY) similar drug alirocumab for first to be approved. Very likely Amgen will file first but be approved a little later. Amgen owns 100% of this molecule, whereas Regeneron and Sanofi co-developed it using Regeneron technology.

Here's what we know so far: Evolocumab is given either every two weeks or once a month via subcutaneous injection. High and dose-dependent LDL lowering is reliably achieved. The mechanism of action gives substantial hope that the LDL lowering will translate into similar clinical efficacy to that of statins, especially in high risk patients who either have known coronary artery disease or have CAD equivalent (e.g., diabetics).

These monoclonal antibodies enhance the liver's ability to absorb cholesterol and thereby degrade LDL. This is additive to the way statins work, which is intracellular within the liver (on the HMG CoA-reductase enzyme). Very high maximum LDL percentage reductions have been seen from evolocumab, and side effects have not been troublesome.

The pool of high risk patients is huge. The question is going to be price and efficacy, of course assuming FDA approval. Statins are known to be highly cost-effective for high risk patients (secondary prevention). Amgen has kept any early outcomes data it may have close to the vest. Regeneron-Sanofi have suggested that what clinical events data they have look promising. My guess is that cardiologists are not going to look askance at this drug class the way they (we) looked at the torcetrapib class of HDL-raising drugs. Evolocumab and alirocumab make sense, though of course they have not proven outcomes benefit yet. I think it's reasonable to speculate that this class of drugs, with Pfizer (NYSE:PFE) in third position with a similar drug, could become the largest-selling drug class in history (along with hepatitis C drugs, I suppose). If evolocumab should, within a few years, be given to one million people a year at $8000 to Amgen, that would make it an $8 B product, with lots of growth potential. It could easily at that early time in its life cycle be worth 10X sales, or $80 B. Depending on the degree of competition and what price point these products sold for, I could easily see Sovaldi-like sales (Sovaldi is annualizing at $14 B in only its second full quarter of sales).

Success with evolocumab would assist the marketing effort for ivabradine.

Then there is the rest of the pipeline. Unfortunately, it's difficult to guess at sales and growth rates for most of the late-stage products, but some look attractive and differentiated, and worthy of premium pricing.

To summarize this phase of the analysis, this unconventional way of evaluating AMGN suggests that it is fairly valued apart from its pipeline. Adding in the pipeline's value, I would say that at least AMGN is mildly-moderately undervalued. Optionality from possible mega-blockbuster success of evolocumab could lead to the stock moving much higher.

Discussion: Alert readers will have noted that I have not discussed EPS yet. Forward EPS are about $9 for next year. Free cash flow generation could be $10/share at that level. Given today's rock-bottom interest rates, what level of FCF yield do you demand to own a share of one of the world's greatest-ever stocks, operating in one of the great growth fields of this or any era, and a company that is clearly in a strong and much-welcomed turn-around phase? Plus, AMGN is the only biotech that pays a dividend, and it is a market dividend around 2%.

If you demand an 8% FCF yield, you are tougher than I. Given challenges in Amgen's core, mature franchises, I would say that 6% FCF yield overall is fair, given (to repeat) that I believe that this is a reinvigorated company. That would be a 17X multiple of FCF, suggesting that it could sell at $170 a year from now. Where else are you going to get 6% with inflation protection and potential major upside?

Plus, there is always the possibility that biotech actually goes into a bubble. Chairman Greenspan called stocks irrationally exuberant 39 months before the NASDAQ peaked. The Yellen Fed called smaller biotechs frothy last month. By that reasoning, AMGN could have 38 months to go leading a biotech boom that turns bubbly. You never know. So the upside could be beyond fair value, perhaps far beyond (I do not invest on bubble possibilities, but given this is biotech and therefore "sexy," I felt I should mention the possibility.)

Supporting that possibility is Amgen's recently-announced rationalization of facilities and priorities to support the marketing of its new and pipeline products. It is going to function much more as a San Fran area company rather than one isolated north of L.A. in Thousand Oaks. This is all to the good for shareholders.

Risks: A different view of Amgen is that it is inexperienced in marketing to cardiologists and high-prescribing internists, and does not do a great job with its cardiology products. In addition, its blockbuster legacy products could decline in sales faster than I suggest, and its other late-stage pipeline products could fail to meet expectations. While AMGN has a beta of 0.80 by Value Line's criteria, it remains a biotech and therefore could be more volatile than its safe-haven status suggests. Financial difficulties amongst payors, many of whom are governments, could materially hurt its margins. So while AMGN does not appear to be at much risk of an outright major permanent impairment of capital, it might be a loser for years to come if it simply disappoints.

There are many ways in which permanent impairment of capital could occur from purchasing AMGN shares, even taking dividend payouts into account.

Conclusion: As the world changes and biotech becomes like info tech, i.e. a routine part of our (medical) lives, AMGN already has iconic status and can easily stand a forward P/E of 18X. The company appears to be an improving operational trajectory.

As a dividend-paying biotech, AMGN has much to recommend it. Unlike many biotechs, individuals who own this equity do not have to watch the news daily to see what great or disastrous event or political comment has occurred. You can just sit tight and hope to be right. My sense is that there's not a lot of downside risk here, and that the breakout potential from evolocumab is real and might be spectacular.

As usual, many risks to shareholders exist. The U.S. stock market has tripled in 5+ years and is not cheap.

Given the many assumptions and comments made in this article, I will conclude here by pointing out that much herein is opinion and not fact. I do hope this writeup is of some value to readers and look forward to any comments, some of which may be by readers more knowledgeable than I about some or all topics I have discussed in this article.

Disclosure: The author is long AMGN.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Not investment advice. I am not an investment adviser. I may buy more or sell AMGN at any time.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.