Amgen (NASDAQ:AMGN) and the whole biotech sector have had a tumultuous ride in 2016. After peaking in 2015 much like oil, the biotech bubble popped and the sector entered a steep correction and even bear market. In each of the instances, AMGN's stock price would begin to recover but some new catalyst would emerge such as Hillary Clinton and President-Elect Donald Trump debating about drug prices. These issues have put continued pressure on biotech stocks and AMGN is among them. The difference is that AMGN is now a dividend challenger with 6 years of annual dividend growth with a current yield above 3% and who recently increased its dividend by 15%. Time to assess whether AMGN is a buy at its current price of $150.73.
WHERE ARE WE AT?
What do some of the current valuation metrics tell us? AMGN current price to earnings ratio is 14.6. YCharts indicates that AMGN 5-year price to earnings average is 18.4. Gurufocus.com calculates the company's median 10-year PE at 16.5. The industry median is currently 27.8x. These indicators suggest that AMGN is currently undervalued or trading at a discount to its historical norm and the industry in general.
The infographic below further shows that AMGN's PEG ratio is 2.4x which is considered poor value based on next year's expected growth but that its price to book ratio which is 3.5x is considered good compared to the industry average of 6.0x. This continues to suggest that AMGN presents an interesting opportunity within its industry.
A look at other valuation ratios such as the P/FCF (14.26) and EV/EBIT (11.86) suggest that AMGN is fairly valued at these levels.
There are currently 12 buy ratings, 2 outperform ratings, 12 hold rating and no underperform or sell ratings. The current consensus among 26 polled investment analysts is to buy AMGN which has remained steady for the past two months.
Based on where we are at now, it appears that AMGN is undervalued and could be considered a buy.
WHERE ARE WE GOING?
The infographic below shows what analysts are predicting as AMGN's earnings per share over the next few years.
AMGN is expected to announce soon that its FY2016 EPS is $11.56, which would represent an increase of 11.4% over FY2015. Analysts have an average EPS estimate of $12.48 in FY2017, $12.87 in FY2018 and $13.22 in FY2019. This represents declining growth of 8.0%, 3.1% and 2.7% respectively. This excludes any blockbuster drug that the company announces. The 5-year average growth is estimated to be 7.0% which is less than half the company's last 5-year growth rate of 15.20%. The industry is expected to grow 17.4% over the next 5-years. This demonstrates that AMGN is lagging behind in its industry.
If analyst's estimates are accurate, then AMGN is currently trading at 13.0x FY2016 earnings, 12.1x FY2017 earnings and 11.7x FY2018 earnings. Based on AMGN 5-year and 10-year PE ratios, AMGN is considerably undervalued at current levels. If I use the median PE ratio between the 5-year and 10-year averages (which is 17.5x), based on AMGN's EPS estimates, the stock would be trading around $202.30 in FY2016, $218.40 in FY2017 and $225.23 in FY2018. This suggests that AMGN's current stock price could be undervalued by 34.2% if the stock were to be trading around $202.30. The stock market appears to be pessimistic regarding the company.
Over the next 12 months, analysts are estimating that AMGN would be trading between $157.00 and $209.00 with a median price target of $183.50 which represents a 21.7% upside potential and possibly 38.6% upside potential if AMGN should trade at the highest estimate. What is most important is that based on these estimates, there is no additional downside. This represents a very good risk/reward argument.
IS AMGEN TRADING AT FAIR VALUE?
I used a Reverse DCF to determine how much the market expects AMGN's growth rate to be. With shares trading at $150.67, the market is pricing in earnings to grow at 3.93%. This is less than half what analysts are estimating. An EPS growth rate of 3.93% would translate into an EPS of $10.98 in FY2016. Even the lowest analyst estimate for FY2016 is $11.39 meaning that the market is likely valuing AMGN below where it should be trading.
What is my fair estimate for AMGN? To answer this question, I calculated the fair value of AMGN using three models: Discounted Cash Flow, Graham's Formula, and EBIT multiples.
The inputs I used for the DCF was the 5-year long term growth rate of 7.0%, a discount rate of 9%, a terminal rate of 2% and a starting FCF value of $8.48B. This provided a fair value estimate of $180.50.
The inputs I used for the Graham's Formula include a growth rate of 7.0%, and EPS estimate of $11.56 and a 20-year AA corporate bond rate of 3.69%. This provided a fair value estimate of $192.98.
The inputs I used for the EBIT model has a conservative, normal and aggressive case. Based on AMGN's past 5-year EV/EBIT history, I chose a multiple of 11.0x for the conservative case, 14.7x for the normal case (which also happens to be the median for the past 5 years) and 20.0x for the aggressive case. Revenue estimates were $22.79B in each case. This resulted in fair value estimates of $120.90, $160.38 and $217.12 respectively.
The table below provides a summary and calculations of the estimated fair value of AMGN.
Source: Old School Value
Based on these calculations, the average fair value estimate is $177.95 and the median fair value estimate is $180.50. Based on today's stock price, AMGN is currently undervalued by 18.0% or 19.7%.
Below you will find my risk/reward chart based on the long-term growth rate (7.0%) and the average and median fair value estimates. The red and green lines in the price action chart below represent the trading range of AMGN based on that growth rate. Obviously, when the stock is near the top line, it is not the time to buy and when it is near the bottom line, it is time to consider buying.
Source: Freestockcharts.com (daily view)
Source: Freestockcharts.com (weekly view)
As you can see in the daily view chart, AMGN is right in the buy price box. The gray box shows the median fair value as the upper buy limit. You will notice in both views that I have a gray line. I drew a similar line in my article on Johnson & Johnson (NYSE:JNJ). In both these cases, the stock price remained fairly stagnant between the financial crisis and 2012 but since then the stock price of both companies resumed a similar trading range that was in place before the financial crisis. In a normal case, I would expect the gray line to be the risk/reward low but if pessimism should return, I would expect the stock to trade between the gray and green lines.
Based on this analysis, I consider AMGN a buy and I will be initiating a position shortly in the stock. My only disappointment at the moment is not having done this analysis sooner when the stock price sank to a 52-week low of $133.64. This would have resulted in a margin of safety of 35.1% rather than the current 18-19%. Still, that margin of safety is rather good, still not near my desired 25% margin of safety, but a comfortable margin of safety regardless.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in AMGN over the next 72 hours.
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.