I've been a tad harsh on Amgen (NASDAQ:AMGN) over the past year or more, treating it as good enough to buy on dips but always selling it on rips, either at the $160 price point or higher. Now, based on changes in the fundamentals and technicals of both its peers and the larger stocks (NYSEARCA:SPY), another beat-and-raise quarter makes it worth taking a fresh look at this venerable name.
First, a Dragnet approach: just the facts; then the interpretation. Note, all data are GAAP unless I either mention it or make a mistake.
AMGN's Q2 - the basics I'm focusing on
To begin with the very basics, from the press release:
- Revenues increased 6 percent versus the second quarter of 2015 to $5.7 billion.
- Product sales grew 5 percent driven by Enbrel® (etanercept), Prolia® (denosumab), KYPROLIS® (carfilzomib) and XGEVA® (denosumab).
- GAAP earnings per share (EPS) increased 15 percent to $2.47 driven by higher revenues and higher operating margins.
- GAAP operating income increased 15 percent to $2,380 million and GAAP operating margin improved by 3.8 percentage points to 43.5 percent.
So far, very good.
A bit of explanation for investors who are not up on every detail of AMGN's large product line. Prolia and Xgeva are basically the same drug, a monoclonal antibody called denosumab. Prolia is used for osteoporosis treatment; Xgeva at double the dose for bone metastases. These have long duration patent and/or regulatory protection in both the US and EU. After Enbrel, these are now AMGN's key drug(s).
The results were a "beat" of about 10 cents on EPS and about $120 million on sales.
That means that the improved guidance shown next does not project much additional upside for Q3/4; but no one would be surprised if AMGN hasn't been sandbagging the entire year all along. Here's the new guidance:
2016 total revenues guidance increased to $22.5-$22.8 billion; EPS guidance increased to $9.55-$9.90 on a GAAP basis and $11.10-$11.40 on a non-GAAP basis.
With the stock around $170 after hours Wednesday night as I write this, that would put the stock around 17X 2016 estimated EPS.
Another positive comes from the company's balance sheet improvement. Per the presentation in the press release, note the improvement in shareholder equity despite reducing shares outstanding, paying dividends and amortizing some intangibles:
Consolidated Balance Sheets - GAAP
Cash, cash equivalents and marketable securities
Trade receivables, net
Other current assets
Total current assets
Property, plant and equipment, net
Intangible assets, net
Liabilities and Stockholders' Equity
Accounts payable and accrued liabilities
Current portion of long-term debt
Total current liabilities
Long-term deferred tax liability
Other noncurrent liabilities
Total liabilities and stockholders' equity
I like to see this trend.
That's it for the good news presentation, for now. A 15% y-o-y EPS improvement, if sustained, would make a prospective 17X P/E cheap in this market.
Can anything like that P:E:G be anticipated?
Some flies in the growth ointment
There's some good news that can be neutral or even negative news when thinking of compounded growth rates going forward. This is summarized in the press release in the section titled "Operating Expense, Operating Margin and Tax Rate Analysis:"
- Cost of Sales margin improved by 1.6 percentage points driven primarily by manufacturing efficiencies and higher net selling price. Research & Development (R&D) expenses decreased 7 percent driven primarily by transformation and process improvement efforts and lower spending required to support certain later-stage clinical programs. Selling, General & Administrative (SG&A) expenses increased 11 percent driven primarily by investments in new product launches. Total Operating Expenses were flat year-over-year, with all expense categories reflecting savings from our transformation and process improvement efforts.
- Operating Margin improved by 3.8 percentage points to 43.5 percent.
- Tax Rate decreased by 2.0 percentage points...
All in all, congratulations on operating improvement. However, this trend does not look sustainable. A question was asked during the conference call on this; management suggests some additional efficiencies can be gained, but probably not much. After all, there's only so much R&D that can be cut, and with a P/E more than twice that of Gilead (NASDAQ:GILD), AMGN can face a much lower P/E if it cuts R&D spending a lot. Furthermore, tax rates are already low for this company; it's not credible for them to go lower. Finally, manufacturing efficiencies might improve a little, but at some point, the costs are what they are. AMGN has been an exceptional company over the years from a quality control standpoint and quality costs money.
Overall, I continue to propound the same theme about AMGN from a purely business standpoint that I've been saying ever since I began covering it nearly two years ago. Namely, that CEO Bradway has been doing a fine job in that regard, which is within his area of competency as an MBA.
Now let's look at whether the sales growth is sustainable, can accelerate or even turn negative.
AMGN's sales volume is flat; not a good sign
The Q2 earnings conference call presentation has a number of slides that describe the company well. The company deserves real congratulations for its transparency in presenting the product-by-product slides with a clear breakdown of where the growth or slippage came from - that is, changes in price, units shipped or inventory.
Slide 14 is important, as it deals with AMGN's flagship product, Enbrel, with this headline:
Q2 '16 ENBREL® SALES GREW 10% YOY
But it appears that price represented about 14% of that, with units shrinking 2% and inventory changes also subtracting 2%. US sales rose from $1.28 B to $1.42 B, with small and relatively stable international revenues noted as well. At nearly $6 B annualized revenues, Enbrel represents over 25% of AMGN's revenues.
With a number of oral competitors coming, I have begun to doubt that any more material price increases can be imposed beyond this year. A pointed question on this topic was presented to management:
Cory W. Kasimov - JPMorgan Securities LLC
I wanted to ask about pricing as well. I'm really curious on how we should be thinking about the sustainability of price increases in this environment. More specifically, when thinking about Enbrel and the four meaningful increases you've had in the last couple years, I assume you're not getting much pushback at the payer level to be able to push these through. But are you comfortable with us modeling this pace of increases to continue, as I think many were assuming this would tail off across the space given the rhetoric that's out there?
Anthony C. Hooper - Executive VP-Global Commercial Operations
So, Cory, again, a question that a lot of people are asking I'm sure. But as you know, we price our products based on the value in the marketplace, taking into account the value they bring to payers, to providers, to patients, the competitive landscape itself. Enbrel in particular of course competes in a highly competitive marketplace with several large players who are competing for formulary placements to enable patient access. The health plans and the PBMs negotiate price concessions and large rebates to gain formulary placement. Because of the magnitude of these rebates, price increases have become part of the competitive dynamic. That's about all I can tell you at the moment.
Well, that clears things up, right? Mr. Hooper used "compete" or its adjective three separate times. That's almost as often as AMGN has taken price increases in the last couple of years on Enbrel, according to Mr. Kasimov.
My view is that it is a potentially serious mistake to not allow for a real possibility that as soon as next year, and even more likely by 2018/9, Enbrel sales could be on a rapid decline. Competition from orals is going to be very tough, as well as from newer entrants in the injectable space. Enbrel is pretty much a rheumatology drug for analytic purposes, largely rheumatoid arthritis, though it has five indications.
Note that in the slide show, AMGN listed Prolia/Xgeva first, ahead of Enbrel. I think that signals something bad for shareholders, no matter how the biosimilar challenge against Enbrel comes out.
How fast can Enbrel decline once the price-raising turns to price stability and maybe to price-cutting?
Let's look at the other legacy products, which AMGN admits are legacy products.
Legacy products remain the fly in the ointment; still far too large to ignore. Here they are in the order presented in the press release with yoy revenue trends:
- Neulasta sales down 1% at $1.15 B
- Aranesp sales up 5% at $504 MM
- Epogen sales down 33% at $331 MM
- Neupogen sales down 23% at $196 MM.
The Aranesp + Epogen sales were down yoy. The company has innovated with a Neulast on-body injector, which is patent-protected to an extent and technically difficult to copy, but these four legacy products annualize above $8 B. How does one model their continued decline? It's not easy to do.
More important, combining their sales with that of Enbrel gives an annualized sales of $14.6 B.
Once Enbrel even flattens out, that presents a huge burden for the rest of the company to overcome if it wants to avoid a 10X P/E for the stock.
Can they do it? I'm a little dubious.
Prolia/Xgeva continue rapid growth but largely stand alone as material growth drivers
These grew 30% and 15% respectively to $822 MM. That makes denosumab a $3.3 B molecule. AMGN's done a fine job with this product. There are years of growth ahead.
The other growth product with material sales is Kyprolis, which grew 45% to $172 MM. The company spoke optimistically in the conference call about Kyprolis becoming a backbone product in myeloma.
I don't know about that. Competition is truly intense in that space, which is however growing in patient-years as patients live dramatically longer. Still at under $700 MM annualized, though clearly on its way to being a $1 B product, growth can be offset by declines in Enbrel and the other legacy products.
Nothing else has the combination of large enough sales with enough growth to really affect the growth picture.
It is slide 11 of the presentation that crystallizes AMGN's challenge. Sales grew 5% y-o-y. That growth was composed of 6% price, zero unit growth, and -1% inventory contribution (destocking).
What's happened to the growth story?
It hasn't materialized.
Can it appear?
Pipeline and new launches - what can they do; what will they do?
There's still hope for Repatha, but unfortunately for AMGN, cardiac events have been accruing more slowly than expected. Outcomes data are now expected in Q1 2017. Assuming they are positive, which of course is not guaranteed, it will take perhaps to Q4 for an outcomes indication to enter the label. Labeling for an indication may be required to really engage the payors. At $27 MM in Q2, worldwide Repatha sales represent the most pathetic launch of a purportedly major product I can recall. In the prepared remarks, Tony Hooper said this about Repatha:
Our cardiovascular teams have executed well in the marketplace, but strict utilization management criteria and processes employed by the insurers and PBMs continues to be the biggest hurdle. We're working diligently to address these restrictions so that appropriate patients are able to access the treatment their doctors prescribe for them.
They are still blaming the payors rather than themselves for grossly overpricing the product.
Similarly, AMGN has completely botched the rollout of Corlanor for heart failure. Not only did they over-promote it without showing an understanding of its unusual difficulties of use from a prescriber's standpoint, but a key decision was punted on. That decision should have been a CEO decision, as follows. The pivotal study for Corlanor showed a statistically non-significant trend toward greater survival. If a company AMGN's size was going to stand behind this drug, it should have organized a larger outcomes study to prove the point. This would have been similar to what the best biotech of its time (and of all time), Genentech, did in the 90s when its Activase was in competition with the much less expensive streptokinase. Genentech did a large and risky outcomes study. It worked. Activase justified its price premium.
Now, no one forced AMGN to do the CHF thing with Corlanor. But if it was going to do it, introducing it as a more expensive digoxin, with much greater difficulties of use, without proof it was superior to digoxin, was a mistake. More than a mistake, the failure to decide makes me wonder if the CEO fully understood the dynamics in play here.
The combination of not one but two poor, really disastrous launches in the CV field is a serious negative for me in thinking of making a long-term commitment to AMGN shares.
The CV story gets worse, exactly as I have been predicting all along. Last September, AMGN announced this:
Strengthens Amgen's Cardiovascular Portfolio With Late-Stage, Oral CETP Inhibitor
This was a $300 MM cash deal with further contingent payments. AMGN expressed great optimism not only about the drug but about its coming CV franchise, saying in the press release:
"With the recent launches of Repatha™ (evolocumab) and Corlanor® (ivabradine), and today's acquisition of Dezima, Amgen is proud to be on the leading edge of an exciting new wave of treatments for cardiovascular disease, an illness impacting millions of people worldwide," said Robert A. Bradway, chairman and chief executive officer at Amgen.
Not so fast.
I criticized the deal at the time. Now we learn, not even from the prepared remarks but only (grudgingly) in response to a question, this (bolded emphasis added):
Sean E. Harper - Executive Vice President-Research & Development
Sure. I think at this point in the game, most folks are really just waiting now to see the Merck CETP study read out. I assume midyear next year is what we've most recently heard. Before making any final judgments, I would say that the Lilly data did cause folks who were believers in the mechanism to take significant pause. And certainly, what we've done is to suspend any investment in this area until we see the Merck data.
Not only that, but the fourth leg of AMGN's planned CV strategy is moving slowly. That's omecamtiv, a positive inotrope for CHF. There was this skeptical question in the Q&A, followed by a defensive response:
Neena Bitritto-Garg - Robert W. Baird & Co., Inc. (Broker)
Hi, this is Neena on for Brian. So I had a question about omecamtiv. I know you said that the Phase 3 protocol has been submitted, but we were just wondering what the gating factors are to starting a Phase 3 trial, just because we know the Phase 2 data has been out for a while now. So are there regulatory issues or something like that that's holding it up, or something else?
Sean E. Harper - Executive Vice President-Research & Development
What I would say is that we have been moving aggressively with this program. We had to of course go through some meaningful discussions with regulators around things like the dosing algorithms that would be used, safety of the product, and so on because of the fact that just based on the mechanism and there is a narrow therapeutic window for the product, and when we're assessing drug levels and how the titration scheme. So that's moved along. I think we've been able to design a very robust study and have decided that we should put it through the Special Protocol Assessment at FDA. So things are actually moving along as fast as I would have expected to on a complex program like this.
I have raised questions about whether the elevated blood troponin levels associated with omecamtiv use imply that it's unsafe. Omecamtive reminds me conceptually of the positive inotropes that the industry was excited about perhaps 20 years ago. Then it turned out that while cardiac function was strengthened and some people lived longer and felt better, an equal number died from the drug. I suspect I'm on the right track, given AMGN's concern about "safety" and "narrow therapeutic index."
Overall, AMGN's efforts in the CV space represent, in my humble opinion, a constellation of errors. All it had to do was launch Repatha successfully, not try to develop a franchise where Pfizer (NYSE:PFE) and other giants have dominated for decades.
As far as the rest of the young launches, Blincyto and Imlygic in oncology are going to be nice products. I doubt that either one will move the EPS needle enough to really matter, though.
The late-stage launches that are upcoming of "romo" for osteoporosis and Parsabiv to supplement/replace Sensipar, which I believe goes generic in 2018, are not exciting. I've analyzed those two candidates in detail previously, so I won't comment now.
AMGN is in Phase 3 with its migraine antibody, being developed with Novartis (NYSE:NVS). It is now calling this erenumab; it was formerly AMG 334.
If we exclude the large biosimilar program, which I'm quite positive on, I think that AMGN has a weak late-stage pipeline given its size and P/E.
Concluding remarks - not enough value drivers here to match the risks
It's almost impossible in this overvalued market to actually guess where a stock will trade. So I make no predictions. Worse stories than AMGN (sometimes much worse) are trading at much higher P/Es. So in comparison to the market, my opinion of AMGN stock is that it's more attractive than average within the very large cap or mega-cap space, but that its other peers are executing better, have better earnings yields, and/or have better pipelines and more focused R&D efforts.
I would like AMGN better for the long haul if it stayed within a smaller number of therapeutic areas and had senior executive leadership with more of a scientific-medical background.
So in conclusion, after a reasonably thorough reassessment, I don't see any special attractiveness of AMGN at 17X prospective 2016 EPS relative to my ongoing and well-known favorite biotech/biopharma peers. However, there are several potential growth drivers, and AMGN is a favored name on the Street. So I still hypothesize it as range-bound and plan to trade it that way.
Thanks for reading; I look forward to seeing your thoughts.
Disclosure: I am/we are long 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.