With uncertainty in macro trends and volatile markets, investors should consider shifting to industries with inelastic demand. Biotechnology provides some of the greatest upside with predictable bear-case scenarios. Amgen (AMGN) and Merck & Co. (MRK) were two of my top picks that have illustrated the benefits of biotech investing. Since I first published my bullish article on Amgen here, the stock has gone up by 12.1%, beating the Dow Jones by more than 980 basis points. Since I first published my bullish article on Merck here, the stock has gone up 8.2%, beating the Dow Jones by almost 600 basis points. With the other emerging and small biotech down tremendously, Ampio (AMPE), investors have a key opportunity to benefit from the market returning to normalcy and fair value. I remain bullish on the sector, overall.
From a multiples perspective, Amgen is the cheaper of the two. It trades at a respective 16.3x and 11.2x past and forward earnings while Merck trades at a respective 26.4x and 10x past and forward earrings. With that said, the latter does offer a dividend yield of 4.4%, which is double that of its competitor, and is rated near a "strong buy" on the Street. I find that given challenges for Johnson & Johnson (JNJ) in Xarelto and Novartis AG (NVS), the cheapest of peers, trading at 13.4x past earnings, to name two, both companies are positioned to go nowhere but up.
At the third quarter earnings call, Merck's CEO, Ken Frazier, noted strong performance:
"I'm pleased to report that we had another good quarter. We coupled top line growth with strong expense management to yield an 11% increase in non-GAAP EPS. In addition, this quarter, we were very active in repurchasing our shares. At this point, 3 quarters through 2011, I can report that we are successfully delivering on our stated intent to grow both the top line and the bottom line, maintaining the consistent execution we've seen all year.
While we transitioned rights to REMICADE and SIMPONI in certain countries this quarter, we were still able to drive 8% year-over-year growth in our overall business".
Merck may be known for having one of the weaker pipelines in the industry, but it has 17 potential launches. As the market may not be fully acknowledging this innovation, the company does have a surprise story going for it. This will help drive risk-adjusted returns, closing off just some of the discount to intrinsic value. Furthermore, the company is strong from a competitive standpoint, since almost just one tenth of the business faces generic competition. For other firms, the figure is more than double that. MK-6096 demonstrated efficacy in sleep tests and could bring in $200M worth of revenue in 2015. Add in penetration to the mix and you have an attractive defensive play. Risks, however, include the $50B patent expiry for prescription production over the next several years and a more aggressive FDA.
The consensus estimate for Merck's EPS is that it will grow by 9.6% to $3.75 in 2011, grow by 2.1% in 2012, and then decline by 0.5% in 2013. Assuming the company sinks to the multiple that Novartis is at and applying a conservative 2012 EPS estimate of $3.79, the rough intrinsic value of the stock is $51.17, implying 32.8% upside. A forward PE is just too low for a company of this potential.
Similarly, Amgen has attractive risk/reward. Opex may have risen in the third quarter, but there are several top-line drivers that will more than offset structural problems. Xgeva, in particular, is attractive to urologists due to its efficacy for metastatic patients. The former president of the Large Urology Group Practic Association called it a "foundation" for the treatment of prostate cancer. Xgeva and Prolia are exceeding expectations and will also drive mid- to high-single-digit return in the bottom line. Strong results have also been seen in Neupogen and Embrel. This has been partially offset by weak November sales in Npogen and Neulasta. In addition, tougher labels pose strong competitive pressures for amenia drugs Aranesp and Epogen.
Consensus estimates for Amgen's 2012 EPS are that it will accelerate: growing by 2.1% to $5.32 in 2011 and then by 10.3% and 11.6% more in the following two years. Assuming a multiple of 14.5x and a conservative 2012 EPS of $5.73, the rough intrinsic value for the stock is $83.09, implying 26.5% upside. Again, the forward multiple of 11.2x is just too small to have any meaningful downside.