Regeneron Disappoints, The Stock Sells Off: Analysis Of Its Growth Potential

Summary

REGN, a stock which continues to trade on its growth potential, sold off (again) after reporting Q4 results Tuesday.

The company is investing in Eylea, Praluent and multiple late-stage and earlier candidates.

This article focuses on Eylea with commentary on Praluent and other aspects of the company's potential growth drivers.

My view of REGN remains bullish and patient.

Background

After Regeneron (NASDAQ:REGN) reported its Q3 results in 2014, I wrote about it with this description:

  • Regeneron missed some analysts' expectations for sales and EPS, sparking a nearly 6% sell-off in the shares.
  • Barron's jumped on the bearish bandwagon.
  • Yet, the bull case for REGN continues to strengthen, as this article discusses.

REGN closed that day, early in November 2014, at $372.

Here it is, 15 months later, and the shares closed Tuesday at $366, down 6% on the day. Just as I defended the stock against a minor "miss" to expectations then, I remain bullish on the shares now, in the context of my very cautious attitude toward the stock market (NYSEARCA:SPY) as a whole. But, on the bottom-up rather than a top-down approach, with a multi-year view of REGN, here's why I like the story more and more given the sell-off.

REGN - A brief discussion of Q4 and FY 2015

The earnings report as usual has a lot of details for this company with only one commercially important marketed product. This summary provides a good snapshot of recent financial history:

Financial Highlights

($ in millions, except per share data)

Three Months Ended

December 31,

Year Ended

December 31,

2015

2014*

% Change

2015

2014*

% Change

EYLEA U.S. net product sales

$

746

$

518

44

%

$

2,676

$

1,736

54

%

Total revenues

$

1,098

$

802

37

%

$

4,104

$

2,820

46

%

Non-GAAP net income(2)

$

327

$

328

-

%

$

1,404

$

1,175

19

%

Non-GAAP net income per share - diluted(2)

$

2.83

$

2.79

1

%

$

12.07

$

10.00

21

%

GAAP net income

$

155

$

90

72

%

$

636

$

338

88

%

GAAP net income per share - diluted

$

1.34

$

0.78

72

%

$

5.52

$

2.98

85

Click to enlarge

However, it's quite incomplete, as any one photo of a complex and evolving structure must of necessity be.

The company is accomplishing this while evolving at a pace I have never seen before in a younger pharmaceutical company, and this means I'm referring to 35 years of following (and participating in) the industry. So I think that as per the old vaudevillian Jimmy Durante, we ain't seen nothing yet.

Currently, REGN has three major sources of revenues. The major one comes from its own marketing of Eylea, its only major source of product revenue. A second major source of revenue is the remittance from the international marketer of Eylea, Bayer A.G. (OTCPK:BAYRY); this revenue is essentially all pre-tax profit to REGN. A third source of revenue is from its partners, principally Sanofi (NYSE:SNY), for R&D. This last source of revenue ends up getting repaid from product sales, so it's not much of a source of profit if at all.

As shown above, revenues grew rapidly yoy in Q4, with some deceleration from the blended growth rate of the first three quarters of the year. To the modest extent, this was due to deceleration of Eylea's sales versus payments from Sanofi, my guess is that we have seen this movie before, as in 2014 when I shrugged off the market's reaction to a "miss."

Just to show what a poor forecaster I was in 2014 and how much progress Eylea has made since then, I said the following in the above-linked article:

I foresee that between Eylea, which in perhaps 2-3 years could be bringing in $3 B revenue to REGN...

This is what REGN reported yesterday:

For the full year of 2015, net sales of EYLEA in the United States increased 54% to $2.676 billion from $1.736 billion for the full year 2014...

For the full year of 2015, net sales of EYLEA outside of the United States(1) were $1.413 billion, compared to $1.039 billion for the full year 2014. For the full year of 2015, Regeneron recognized $467 million from its share of net profit from EYLEA sales outside the United States, compared to $301 million for the full year 2014.

So the total revenue to REGN in 2015 from Eylea exceeded $3.1 B, meaning just the very next year after I was guessing it would do that 2-3 years later.

It's been an amazing year, and I would take management's projection of 20% yoy US Eylea sales growth with a large grain of salt. The management is notoriously conservative in these matters; note that it only forecasts Eylea sales where it markets, in the US. Also, even despite the adverse forex translations, Eylea is growing like a weed ex-US. The management made clear on the conference call that Eylea has more potential market share growth ex-US than in the US. This may reflect a later start for Bayer as well as, perhaps, greater strength of Eylea's major competitors, Lucentis and generic Avastin, both of which are manufactured by Genentech, a Roche AG (OTCQX:RHHBY) subsidiary.

I'll get to the other aspects of the quarter later in the article, but for now, Eylea and its prospects are so important that they're worth their own sections.

Why REGN's eye franchise could be worth its entire market cap - and more

Counting pending dilution, REGN may have a market cap of $40 B.

There are three ways I think of the cash flows from its eye franchise.

1. Bayer income

The simplest to analyze is the pre-tax income from Bayer. This was $467 MM last year. Perhaps after taxes, that translated to $300 MM cash. Growth was outstanding, well over 50% yoy. Whether the tax rate will stay high is to be determined. I expect net income growth for REGN from ex-US regions for years to come from Eylea.

2. US income from Eylea

Quantitatively, this is the largest contributor; eventually, there are more eyes ex-US, but reaching them will take time. For the near- and intermediate-term, the US is the big contributor to Eylea's income.

Unlike the situation with Praluent and the planned launches in RA and eczema, REGN owns 100% of Eylea in the US. Its COGS specifically for Eylea in the US is low, but not specifically broken out in the press release. Given the small number of doctors who prescribe Eylea and its high cost, my guess is that attributable SG&A is also quite low as a percentage of revenue. Thus, I believe that pre-tax profit margins on Eylea sales in the US are extraordinary. If so, this puts REGN solidly in the specialty pharma category of developing and marketing high-priced breakthrough or best-in-class medicines that bring extraordinary financial rewards to the innovator. Of course, Gilead (NASDAQ:GILD), Celgene (NASDAQ:CELG) and Biogen (NASDAQ:BIIB) are current large-cap biopharma companies that have accomplished this.

Eylea reached almost $2.7 B in sales in 2015; Q4 sales annualized at almost $3 B. If Eylea reaches $3.5 B this year in the US, and assuming about a 40% tax rate, that could produce a 50% net after-tax margin, or $1.75 B.

If ex-US profits rise rapidly this year as well, then the after-tax profits attributable to Eylea could be $2.2 B. Here's why I expect this to increase into 2017 and beyond, until the third leg of the franchise (see below), the pipeline, kicks in and potentially sends the franchise into Humira-like levels.

Here's a summary of REGN's in-house pipeline and growth potential for Eylea to treat vascular eye diseases. I'll omit the alliance with Avalanche (NASDAQ:AAVL)

REGN - Aiming to dominate with Eylea-based treatments for years to come

1. Eylea in DME - Big gains ahead?

Firstly, Eylea and its direct competitors are all competing against laser therapies, and substantial growth for its existing indication for DME (diabetic macular edema) is foreseen. Per the comments from Dr. Yancopoulos in response to a question from Geoff Meacham:

So, Geoff, obviously we have seen a lot of our growth this year coming in the DME segment of the marketplace. Unfortunately, there still are a large number of patients who have diabetes that don't get yearly-dilated eye exams, don't get into the retinal specialists. And so DME is currently still undertreated although VEGF inhibitors are being used more broadly for patients who are diagnosed with DME, the opportunity for us is to make patients aware that they've got to get their eye exam and get into a retinal specialist if they do have any problems with their vision. And that really is a major focus of our promotion this year...

It's still true that unfortunately despite the data showing that anti-VEGF therapy can provide much better vision results than laser therapy, laser is still the preferred therapy in the DME population. There's a lot of patient education and doctor education there. And as Len said, that's just for the approved setting DME diabetic population. There's at least three times as many patients who have diabetic retinopathy without DME. So if the current studies really show their results, there's an opportunity there as well.

The above arguments appear reasonable to me. Especially as the percentage of the growing numbers of older people with diabetic complications increases, I think that DME is a growth field for Eylea and its competitors. With the results of the study done by an arm of the NIH showing that in patients most in need of treatment, Eylea was superior to either Genentech's product or it also has the potential for further market share gains against Lucentis and off-label Avastin.

2. Eylea in diabetic retinopathy - A very large new opportunity

As suggested by the final lines of the quote above, currently Eylea is indicated for edema (swelling) of the macula (a central part of the retina) associated with diabetes. But my understanding as a non-ophthalmologist is that Eylea probably also has efficacy in the broader, more common condition of vascular disease of the retina in association with diabetes, called diabetic retinopathy, where macular edema is not present.

REGN is initiating a Phase 3 trial for DR this year, called PANORAMA. Also, beginning this year is a multi-year study, Protocol-W, by the DRCR, the NIH organization. REGN has other Eylea studies planned or underway. This suggests to me that it wants to do what it can to turn Eylea into a Humira-like franchise with numerous specific indications. If the company can achieve that, then Eylea can roll along even as new competitive products and newer combos containing Eylea come to market.

3. Eylea combos

REGN now has two co-formulated combo products, each containing Eylea as one of the two drugs, in Phase 2. Data from the lead combo are expected soon. If the results are supportive, the company has not disclosed a timeline for entry into Phase 3. In thinking of the competitive threat from Ophthotech (NASDAQ:OPHT), REGN's thinking is that one injection into the eye to deliver two drugs is significantly better than two separate injections each delivering one drug. Thus, it thinks that the bar will be set higher for the latter situation than for a co-formulated product, not necessarily with the FDA but at the least with patients and clinicians.

Eylea and beyond - Summary of REGN's financial opportunity in vascular eye diseases

There is competition, and there are no certainties of success in any of the above attempts at line extension.

However, eye diseases are proliferating (pun intended), and REGN has come from nowhere in 2011 to take the lead from Genentech in VEGF treatments. Looking many years forward, the field may do nothing but expand as new indications, better drugs, etc. join with an expanding pool of people with diabetic and non-diabetic vascular diseases of the retina to provide literally endless growth opportunities.

I do not think that it is unreasonable to take 2015 profits from Eylea, potential 2016 profits from it, and project significant compounded annual growth for years to come for REGN.

In my view, one of the factors that has slammed biotech stocks has been a sharp rise in the discount rate, tied to rapid, major increases in junk bond interest rates. This affects REGN as well. Given all the complexities of competition, possible pricing restraints, etc., I'll leave this topic here for now, but my guess is that so far, the portents for Regeneron in Eylea-based therapies are positive.

Next, a word or two on Praluent.

Will Praluent deliver big profits?

So far, Praluent has had nominal sales. Basically, the company is focusing on patients with known coronary disease and the much less common pool of heterozygous familial cases of high cholesterol. Negotiations with payers are said to be moving along adequately, and REGN touts a strong success record in competitive negotiations with payers, especially for Medicare Part D.

Most important, the company is going to have one or two interim looks at the data in its ODYSSEY outcomes trial for Praluent in acute coronary syndromes. As I had hoped, it is emphasizing sub-group analysis here.

My view remains that both REGN (with its lead partner on Praluent Sanofi) and Amgen (NASDAQ:AMGN), with the similar drug Repatha, continue to have massive sales and profit potential in this space. I do not think that sales to date matter except that in the pharma business, the investments made first in R&D and then in building a sales force are almost completely expensed as the funds are spent, so that future profits drop straight to the bottom line without amortization charges (other than for PP&E and the like). Right now, Praluent is a major loss-making part of the business, but I'm hopeful that positive outcomes data both for Praluent and Repatha will allow the companies, payors, prescribers and patients to find price points that allow cardiovascular health of the many potential beneficiaries of these novel drugs to have widespread access to them.

Other opportunities

This has been covered extensively by me. REGN provided updates in its press release, prepared remarks and again in the Q&A. I am not going to comment again in this article on sarilumab for RA and dupilumab first for eczema (atopic dermatitis) and later for asthma and possibly other indications, as I've spilled a lot of digital ink on them many times before.

The progress here is, as CEO Len Schleifer mentioned, quite special. Some of the new news made yesterday was that its nerve growth factor inhibitor fasinumab has received FDA approval to engage in a long-term study, which REGN plans to begin this year.

Also new is the news and commentary on one of its growing candidates on oncology. In the Q&A, Nick Abbott asked a question related to this topic:

Can I just go back to the PD-1 inhibitor? The trial has ballooned from 60 to now apparently 973 patients.

Dr. Schleifer, the CEO, responded:

And so the programs are going well. They have obviously been enlarged because we're pleased with the initial results that we're seeing and we'll be sharing some of that with you at the upcoming appropriate cancer meetings.

I take that as a typically reserved REGN comment. Rather than tout promising but early-stage data, it's keeping it in reserve but moving forward aggressively in the clinic.

In addition, the company indicated that it has a productive early-stage set of candidates, with a record number of INDs filed with the FDA and getting ready to move into the clinic.

I take this and the expansion of the company in multiple locations as evidence that it expects to achieve major company status in the years ahead.

Risks

REGN is probably now under a cloud, as Praluent sales have fallen below even the restrained expectations and the company is projecting slowing Eylea growth. Risk assets such as junior biotechs have of course been materially repriced lower, and even GILD, though rebounding almost 10% from its recent lows, has been marked down to what might be an all-time low P/E for any major biotech stock.

REGN may never pay a dividend, and the market might mark the stock down for years even if it meets most of its growth objectives. So I continue to view this as a stock that's not suitable for all investors by any means.

Beyond the above, I have significant concerns about the SPY and general stock market indices, which I view as having very large potential downside risk even if nothing worse than a mild/moderate (i.e. "ordinary") recession befalls the US. Note please that Regeneron discusses risks associated with its stock in detail in its regulatory filings with the SEC, and elsewhere.

Also, please note that as stated above, nothing herein is intended to provide advice to anyone to buy or sell or otherwise make a financial commitment to REGN or any security.

Summary comments

As discussed above, REGN is now trading at and below prices reached in the second half of 2014. That's despite its success with Eylea commercially and scientifically, and the general growth of its pipeline. Again, I caution, pipelines and potential are not the same as money in the bank, and there are no guarantees here.

My view, though, remains that I like the risk-reward in REGN and continue to own substantial amounts of it. My time frame remains one of multiple years, as that's simply how the world works in the biotech industry.

Thanks for reading. I look forward to any comments you would care to share.

Disclosure: I am/we are long REGN,GILD.

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: Not investment advice. I am not an investment adviser.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.