A year ago, Questcor Pharmaceuticals (QCOR) outpaced analysts' expectations, posting higher-than-expected sales and net earnings figures in Q2 of 2011. Personally, I am not surprised investors continue to place bullish wagers on the future of Questcor, given the severe volatility witnessed in the biotechnology market since 2008, the height of the Great Recession.
Questcor, based in California, is the sole manufacturer of the drug H.P. Acthar Gel, which has primary indications for the treatment of adult Multiple Sclerosis, infantile spasms and Nephrotic Syndrome. Acthar first gained approval by the FDA two years ago to modest fanfare.
My assumption is that Questcor's internal marketing think tank did not project that the product would sell as quickly as it did once the drug hit the open market in 2010. New (i.e. very expensive) pharmaceuticals are arguably the most difficult products to bring to market in the first place. They fail to gain a significant foothold in the healthcare industry more often than they succeed. Take the dozens of recalls the Food and Drug Administration issues every year as evidence of this hard-to-deny fact.
After examining the key macro-level, public statistics, I foresee Questcor's honeymoon coming to a close by the start of fiscal year 2013. Drug companies are simply too notorious for catastrophic miscalculations that in the end can potentially cause investors substantial losses. Unless traders are willing to hold the bag for a long period of time, small, meteoric pharmaceutical companies like Questcor are almost always best when short-sold. In fact, the Data Explorers recently published a report which showed that Questcor is now one of the most short-sold biotechnology companies on the market today.
The Hard Facts About Questcor
Conventional wisdom says that financial statistics do not tell the complete story of a company. The numbers do, however, give us a great platform from which to diverge. Currently, Questcor is trading with a trailing price-to-earnings ratio above 30. Compared to similar biotechnology investments, buying into Questcor seems like a safe wager in a gradually recovering global economy. Its operating margin sits at a comfortable 52% while return on equity is equally as optimistic, resting at 46%. From a cash standpoint, Questcor's $85 million operating cash flow is more than adequate in my opinion since the company only produces one primary product Acthar. In reality, Questcor only fills a few hundred prescriptions of Acthar each month.
The problem that I foresee with Questcor centers around its sales trajectory. In Q1 of 2012 alone, demand for Acthar dropped noticeably, but of course, Questcor acted quickly to categorize these unflattering statistics as anomalous. From my point of view, declining sales, increasing competition and a modest 11.8 forward price-to-earnings ratio are cause for caution.
Questcor's Competitors Highlight Its Weaknesses
At the end of the day, Questcor depends on a single drug for the majority of its income. This fact is its greatest liability in my opinion. By comparison, Novartis AG (NVS) manufactures and distributes dozens of pharmaceutical and over-the-counter drugs. Novartis' success does not hinge on a single product, which has allowed the company to diversify well as a drug provider. The exact opposite is true of Questcor, which has only one truly actionable product.
Questcor also compares similarly to Sanofi (SNY). Sanofi's less-than-stellar 21% operating margin should be cause for concern relative to Questcor's hefty 52% margin, but nonetheless, Sanofi projects a reasonable 9.5 forward price-to-earnings ratio. Sanofi maintains only a 10.8% return on equity despite having such a large market cap, so to be fair, Questcor's profitability over the remainder of the fiscal year remains a solid proposition. Ironically, Questcor purchased its trademark drug Acthar from Sanofi a few years ago, an all-too-common strategy deployed by the largest pharmaceutical companies in the world.
Abbott Laboratories (ABT), another drug manufacturer based in America, is superior to Questcor, as well. Investors view Abbott as a superior long-term proposition. Currently, Abbott trades at approximately $60 per share. Questcor is trading around the $40 per share mark at this point in time, but a year ago, it traded for less than $15 per share. By comparison, Abbott has been trading consistently between $45-$60 per share over the last two years. Similar to Sanofi and Novartis, Abbott's $97 billion market cap dwarfs Questcor's $2.5 billion.
Multiple Sclerosis drugs that compete directly with Acthar are the biggest cause for concern in my opinion. For example, Biogen Idec (BIIB) has brought to market Tysabri, one of the most potent medications available for the treatment of Multiple Sclerosis. With a market cap of $30 billion Biogen sits comfortably ahead of Questcor.
Unlike Questcor, Biogen has a diversified range of products. It even has an additional Multiple Sclerosis drug currently undergoing clinical trials. Over the last two years, Biogen has traded as low as $50 per share and as high as $130 per share. Even Biogen's forward price-to-earnings ratio of 18 trumps Questcor's most wildly optimistic projections.
Simply stated, Questcor looks more attractive at a glance than it does when compared to its major competitors. Truthfully, I would not expect Questcor to collapse overnight, but I would feel more comfortable taking a short position as opposed to investing long term.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
