The big question
Is this the breakout for biotechs - including large caps such as are held by the iShares Nasdaq Biotechnology ETF (NASDAQ:IBB), and smaller caps such as are largely held by the SPDR S&P Biotech ETF (NYSEARCA:XBI)?
Is the bottom in, and clear skies lie ahead?
Maybe, but 11% moves in IBB and XBI in a month or less are not trivial.
Has much really changed since so many dramatic stock market moves in individual names? Was a Republican Congress really going to do damage to the pharmaceutical industry? No, and no.
Going back to the onset of the biotech sell-offs related to fears of policy changes out of Washington in 2015, I have argued consistently that focusing on the fundamentals was the best way to think of investing in this space. Recent events have persuaded traders that, for now, I was correct.
Fundamentals have not, on balance, changed recently, for the group, but for some individual companies, they have.
So as we still are a month away from biotech earnings season, I wanted to take a look at some of the news on each individual stock.
Using data from Friday's close, the closing price and then P/Es are shown after the stock name. P/Es represent GAAP TTM multiples as shown by ETrade (NASDAQ:ETFC). In alphabetical order, the large-cap biotechs that I have been following and have owned since 2014 are discussed next:
While the market cap is $116 B, ABBV has borrowed heavily to pay both for growth (Imbruvica) and to strengthen its pipeline. Using GAAP, where the TTM P/E is 18.8X, mostly takes the debt into account. Using the higher non-GAAP EPS that the company and Street prefer, one then needs to take the tens of billions of dollars of net debt into account.
There were some negatives lately:
- Invalidation of a Humira patent, set to protect it until 2022, that ABBV's management had repeatedly pointed to as key. Earlier biosimilar competition may loom, and in any case, management's credibility has now been damaged.
- Bad news for a major Phase 3 asset, veliparib, which flunked Phase 3 trials for two separate indications.
- Drop in dividend from my entry level of 4.15-4.2% in Q1 to 3.50% (i.e., the stock price rose but the dividend did not).
The first two bullet points are self-explanatory.
The third gets to the point that when the yield was near junk bond yields in the first quarter, the stock could rise simply if interest rates dropped. And indeed, a long Treasury bond fund (NYSEARCA:ZROZ) has beaten the S&P 500 (NYSEARCA:SPY) this year.
Humira is amazing, and ABBV has done an A+ job with it (if not A++), but by 2019, it should have biosimilar competition in the EU (a $4 B annual sales base). If there are then worries about an imminent patent cliff in the US, traders could pressure this name quite a lot. I doubt that the progress on ABBV's good-looking G/P hep C drug, moving toward approval in the US and EU, will matter a lot to the stock given the company's mega-cap status and the competition, mostly from Gilead (NASDAQ:GILD). Having fallen in yield with bonds, thus rising in price, ABBV could now be vulnerable both to interest rate increases and worries about more rapid erosion of the Humira sales base than the company has been arguing would happen.
ABBV is appealing the patent office's invalidation of its Humira patent.
There has been some incremental positive news regarding ABBV's second most important drug, Imbruvica, and regarding the pipeline, but discussion of those can wait until the earnings report.
Given that I think that 16X TTM GAAP EPS is the most I would pay to enter even a generally well-run company such as ABBV, rather than keeping some of the stock, I just sold it all. Since I bought the stock for income, getting 2-3 years' worth of income from appreciation in months was welcome.
Another old name as with AbbVie (the pharma spin-off of Abbott Labs (NYSE:ABT)), AMGN has even greater dependence on aging drugs than ABBV, but AMGN's are spread out over the four blood cell boosters and Enbrel: five old drugs in all. Plus its blockbuster drug for dialysis patients, Sensipar/Mimpara, is heading toward genericization this decade.
AMGN has moved from a trading low around $154 to the current price in just one month. This keeps it within the trading range it has been in since Q4 2014. Since my last review of AMGN, some positive news on its migraine drug erenumab has appeared, but its profits are shared with Novartis (NYSE:NVS). Other modest good news has occurred, e.g. Pfizer (NYSE:PFE) has for a second time received a complete response letter (i.e. a rejection) of its BLA for a biosimilar to AMGN's first drug, Epogen, for a site-specific manufacturing problem.
Over the next six years or less, perhaps 70% of AMGN's revenues are liable to shrink a lot or disappear. For a $128 B market cap stock, AMGN's pipeline, once erenumab comes to market, is weak.
As always, these are just my opinions, not advice, but given the clear and present dangers to the great majority of its profits, the biosimilar business and about half the erenumab business, plus other new products, appear to me to have major challenges replacing the ongoing decline of the legacy products. AMGN also has, as most of the industry has, a low tax rate, so tax reform would appear not to mean much to the stock. So unless its cholesterol drug Repatha can make an amazing surge (which would be a good thing for human health), I do not find AMGN a good source of alpha at the current stock price. But I do not think that satisfied buy-and-hold investors have a reason to sell and incur a tax hit.
I took a trading profit on AMGN and would look to enter if there is another surge of pessimism either in biotechs or in this name, which has so much potential earnings power if it could develop blockbusters better.
There has been some news lately on BIIB. Spinraza has received marketing approval in the EU, the CFO left without a permanent replacement having been named, and its Humira biosimilar, called Imraldi, passed all but the final hurdle on its way to EU approval. Humira loses patent protection in the EU in a little over one year.
The major unreported news that I have seen comes from an article and editorial in the June 13 edition of JAMA about Alzheimer's disease, or AD. I interpret the results as tending to be negative for BIIB's program for its lead AD drug, aducanumab or "adu." One reason: the investigators found that higher brain amyloid levels were indeed associated on a three-year follow-up study with a higher likelihood of cognitive decline, but "the findings are of uncertain significance."
The article and general topic were considered important enough to merit an editorial, which was provided by Dutch researchers. This three-column editorial was a mini-review. The following quote from the editorial is relevant to the BIIB product (emphasis added):
Clinical trials [for prodromal/early AD] are in progress [that] have a planned duration of 3 to 4.5 years, which is within the time period during which the present study showed limited decline in cognition, and so cognitive benefits of these treatment may be small...
...delay[ing] the onset of dementia... may not be evident until 15-20 years later.
This point of view is that even if adu "works," its effectiveness may not be shown by the current clinical trial. Further, it may work well enough to get approved, but unless the data are overwhelming, the question of what value the drug provides would not be answered given the 10+ year window needed to know that.
BIIB has moved up from a $244 low in less than 30 calendar days. I continue to think that the company is reasonably safe in that it has numerous powerful, long-lived earning assets from drugs that are currently on the market. However, I also think that the combination of a thin pipeline with a heavy concentration in AD, plus two years of extensive management turmoil, makes the stock unappealing unless it was cheaper. So, again, the recent run-up matters.
For a company with only about a 10% lower sales base than AMGN, BMY trades at a discount that I find attractive. That's because BMY spends a high 25% or so of revenues on R&D, both for its extensive early- and mid-stage pipeline and its key immuno-oncology drugs Opdivo and Yervoy. If BMY were instead were spending more like 15%, as some of its competitors do, the pre-tax EPS effect looks to be in the range of $1.30 per share.
Might PFE be looking carefully at a bid for BMY? PFE would save on SG&A and cut R&D; the deal might pencil in well at a market-clearing price given PFE's investment-grade credit rating.
BMY's chart is a little ragged, but given how its peers in biotech and its peers in the high-quality sector of SPY are trading, I'm inclined to look upward for BMY into the congested $60-70 range for where it may be heading. It first reached there in 2014, and look what Opdivo and Eliquis have done since then: impressive. Part of the bet on BMY is the bet on Dr. Lynch, the new head of R&D. Much more to come here over the next few years as the massive pipeline moves along.
This has become the gold standard of large-cap growth biotech. Its GAAP quarterly earnings stream has been volatile for a few years, due to numerous one-time charges for pipeline asset acquisition. CELG runs about a 97% gross margin. If it continues as expected through the end of this year, GAAP EPS is expected to be around $6.10. This number assumes no further major deals requiring large current-quarter charges. If the same pattern continues, then the Street is anticipating 20%+ non-GAAP earnings increases for next year. This might imply about $7.25 EPS using GAAP for 2018. For at least the next several years, CELG is in a sweet spot for sales and EPS - and that's with extremely high ongoing (i.e., non-special) R&D expenses as a percentage of sales. I expect that three years from now, the Street will be either obsessing about a patent cliff for all of its major current sales drivers except for Otezla, or it will be taking a ho-hum approach to the same situation (or some mix of the above attitudes). The difference: how the late-stage pipeline has panned out and how the CELMoDs are looking. I'm hopeful but do not know the future, and also do not know how the various generic threats to Revlimid, Pomalyst/Imnovid and Abraxane will play out.
CELG has surged from $115 at the beginning of June, a price I have said more than once was attractive, to the current level - on essentially no news. It may be ahead of itself on a short-term basis, but it remains my favorite biotech, as has been the case since last October when I scaled back into this name around $104.
If things break well with the pipeline, especially the broad CELMoD concept, then CELG can grow for many years and maintain a premium P/E for the stock.
Numerous eyes are on this name as it may be in the early stages of a bearish-to-bullish transition. In the ways of Wall Street, voices are now seen that the worst is over. More interesting to me is that per Yahoo! Finance (YHOO), consensus EPS estimates for GILD have been increasing recently, from $8.20 to $8.35 this year and $7.43 to $7.58 next year, but these are non-GAAP numbers.
Are Rxes for the new line of TAF-based perhaps surprising to the upside to account for the increased EPS estimates?
The non-GAAP "earnings" that the Street likes to present for GILD do not have a fixed difference between GAAP EPS, but using the latest non-GAAP $7.58 estimate for 2018, my guess is that the GAAP estimate is below $7. That would put GILD at perhaps 11X projected 2018 EPS. Whether that is cheap or not, and whether GILD may beat expectations repeatedly now, may depend more on how tough the competition for GILD's HIV/AIDS line from ViiV proves to be and how it looks to be in the coming years. Visibility into international sales and pricing of GILD's HCV line is not good.
So, a lot of questions, but clearly, as with BIIB, most of the market value of GILD comes from marketed products or very late-stage pipeline products. This takes a lot of risk out of the stock without guaranteeing success of the stock over time.
This stock surged 50% from its late April low to a recent high. The major news was the widely anticipated approval of Dupixent for moderate-to-severe atopic dermatitis (eczema) and the also widely expected approval of Kevzara for rheumatoid arthritis. As of 3/31, REGN reported average diluted shares outstanding of 115 million. Multiplying that by Friday's closing share price gives a market cap of $60 B. Meanwhile, there have been a few challenging bits of news. First, Roche (OTCQX:RHHBY) announced this well ahead of REGN's hopes for the same indication for its flagship Eylea:
FDA Approves Genentech’s Lucentis for Diabetic Retinopathy, the Leading Cause of Blindness Among Working Age Adults in the United States
With this approval, Lucentis becomes the first and only FDA-approved medicine to treat diabetic retinopathy in people who have been diagnosed either with or without diabetic macular edema (DME), a complication of diabetic retinopathy that causes swelling in the back of the eye.
This is a plus for Lucentis and thus possibly for off-label use of Avastin in retinopathy. My former bullish model for REGN included more durable growth for Eylea than recent numbers, and REGN's guidance, indicate. Eylea is protected by statute from biosimilar competition until late 2023 in the US, and REGN has not said much about whether it is going to assert patent protection beyond 2023.
Next, REGN soared the day significant additional competition for Eylea in 2019 from Novartis was heralded, per the June 20 press release. There are cross-currents in this press release regarding the effects on Eylea; given that it's based on preliminary data analysis, with full results to be presented at an upcoming medical congress, time will tell whether Mr. Market was correct. More to come on this interesting pipeline drug.
Finally, REGN is a good-sized company now, firmly in the operating category rather than emerging. Yet analysts have apparently been marking down its projected 2017 and 2018 EPS a bit as Q2 has worn on; if Dupixent were doing great and/or Eylea were holding up well, I would not expect this. I think these are non-GAAP estimates. REGN is now mature and large enough that I focus on GAAP for it as for all other substantial biotechs. 90 days ago, analysts were looking for earnings per share of $12.94 and $15.52 for 2017 and 2018; the latest numbers shown are $12.68 and $15.26.
Among the positive factors is that some insiders have recently exercised options but accumulated stock by only selling a portion of the shares acquired.
Given actual and potential legal issues galore, and no good knowledge of the amount of future earnings from Praluent, Dupixent and Kevzara, plus slowing growth (no growth soon in the US?) for Eylea, I cannot put a guesstimated value on REGN. One point for people not familiar with REGN to remember: it happily ended up with perhaps 80% of global profits from Eylea, but is in line for less than 50% of global profits from Praluent, Dupixent and Kevzara; Sanofi (NYSE:SNY) will get the lion's share.
REGN probably has more moving parts than any large-cap stock I follow, not just any biotech.
This stock has sold off with disappointing results in a Phase 3 trial of its most important newer product, the immuno-oncology drug Tecentriq, a direct competitor of Opdivo from BMS and Keytruda from Merck (NYSE:MRK), the leaders in the field. There has, however, been a substantial group of press releases since that negative May 10 release that I assess as having more good news than bad in them. I'll plan to put them in context after the company releases and discusses Q2 results.
Tecentriq is central to RHHBY's growth strategy. The entire field of PD-1/PD-L1 signaling and intervention is being explored in pieces, cancer by cancer, sub-type by sub-type, and drug combination by drug combination.
RHHBY could be a permanent "hold," with the P/E moving as unpredictably as the results of the numerous clinical trials it sponsors. This is the Big Dog of biotech and historically the single most important company in the field. It also has a high percentage of sales that go to R&D, giving it a high quality of earnings. RHHBY is so strong that it has the distinction of having recently borrowed money at a negative interest rate. If any biotech could deserve a median P/E of 30X, I would say it is this one.
It appears for now that traders have finally swung around to my point of view, namely that the biotechs should trade on fundamentals, and that posturing of politicians should not affect share prices. But there's always the next election, and then the next. It's important to think of the value that different drugs, or classes of drugs, create to assess how pricing will hold up. Pharma is a tough business, with return on invested capital unremarkable for all of industry. Reaching to the top, as the Genentech division of Roche has done in protein-based drugs and as CELG and GILD have done in their sectors, represents the fruits of immense effort and skill. I never thought that society would throw away the next generation of drug discovery; more, the opposite, that we all cannot wait to become indestructible (or something like that).
The toughest aspect of biotech investing is that unlike Coke (NYSE:KO) or even an auto company, and certainly unlike AAPL, most brands simply disappear rather than roll along endlessly, as is preferred by Warren Buffett. Biotech funds that "own them all" are certainly appropriate for many investors. There are many such funds, and some will suit different investors more than others. It is possible that very large biotechs could provide broad exposure to the field as well as safety and serve many investors well while targeting the amount of dividends desired.
At this point, as someone who generally prefers individual stocks over funds, I see CELG as best positioned to potentially be "another Apple" while having a reasonable P/E versus the current growth rate. RHHBY and BMY are my next two favorites. All the stocks discussed above have many strengths, though, so in a sense, I like them all; it's just a matter of the price of the stock versus value from current products and expected value from the pipeline. There is a kaleidoscopic aspect to biotech. Lawsuits are won and lost; clinical trials surprise; and the winners change.
Thanks for reading and sharing any comments you have on the sector or any one or more of the individual stocks discussed above. I plan more detailed discussions of each name after they report Q2 numbers.
Disclosure: I am/we are long CELG, RHHBY, GILD, AAPL, BMY.
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.