Introduction: moving past one-product status
Regeneron (REGN) has been dealing with the complications of the immense success it had with its second approved product, Eylea. How do you top an act like this drug, one of the world's best-selling products in only its 7th year on the market? Also, REGN saved dilution or debt early on by two different partnerships with Sanofi (SNY), but the funds or credits going back and forth between the two companies have made straightforward financial analysis difficult.
Then add the uncertainty of biosimilar competition for Eylea either in November 2023 or thereafter in the US, or 2025 in the EU. Add the further uncertainty on REGN's method of treatment patent with Eylea that runs until 2032 in the US and how does one pick a fair value for this stock? It's my guess that once REGN ceased being a momentum play after 2015, these issues kept a lot of analysts from turning bullish even as the stock dropped by 50% from its 2015 highs into its 2018 lows.
Yet REGN's only publicly-known serious mistake - for which I assign a plurality of the blame to senior partner Sanofi - was in overpricing the cholesterol-lowering drug Praluent. Given all the things that REGN has done right, I have stuck with the stock once I saw operations not only stabilizing but improving over the past year or more. Thus, I have spent much of the past year or more buying dips and selling rips, around a core position in the stock. That has worked well, but now I think the better strategy is to accumulate REGN on dips and just plan on holding for a long time, given how low REGN's valuation metrics have sunk. Cheap does not mean riskless; that said, here's my summary case for putting a growing amount of new money into REGN around Friday's closing price of $406.86.
Beginning with the very important contrarian aspect...
Investing against the fear
The best stocks tend to be found when there are reasonable and well-publicized arguments against them. All brand pharmaceutical stocks have been affected by headline risk, given that both major party candidates in 2016 inveighed against the industry, and as recently as the State of the Union address, President Trump specified Big Pharma/Big Biotech as needing to have its pricing further restrained. Of course, politicians talk and may do nothing, but often they talk a lot and do something; REGN's Eylea has been high on the list of investors given that especially for its wet AMD indication, it costs Medicare big bucks.
In addition, REGN periodically gets slammed by publicity about a minimal number of cases of injection-related side effects from Eylea. Beyond those headline-driven sinking spells for REGN shares, realistic fears revolve around new competition expected from giants Novartis (NVS) and Roche (OTCQX:RHHBY), biosimilars to Lucentis and/or Eylea, and possible increased use of Avastin in ocular indications.
What is the Eylea franchise really worth? And how much does it matter in the long run?
Eylea brought in north of $5 B of very high-margined sales to REGN last year, with double-digit growth both in the US and internationally, where Bayer (OTCPK:BAYRY) shares profits. But as mentioned, competition is already significant and per pp. 17-19 of the 2018 10-K, could be much more intense in a few years. In addition to direct competition, there is significant uncertainty about whether REGN can respond with an improved, high-dose Eylea formulation or an improved molecule over the active ingredient in Eylea (aflibercept).
Tying into these concerns is the patent position of Eylea. REGN presents a summary of this on p. 24 of the 10-K. In this case, I have not hired a patent lawyer and expert scientist to evaluate how important REGN's formulation patent (expires 2027) and method of treatment patent (expires 2032) are to Eylea's US prospects after statutory exclusivity ends in November 2023. So I'll just accept the wisdom of the marketplace on this key topic and make one further point, then move on to my newer point of view on REGN.
That point on Eylea, which may not be in REGN's valuation, and which ties into how I now think of REGN, is that REGN now has a leading US eye disease franchise. There are three parts to the brand drug biz. These are:
- Research leading to pipeline candidates for drugs (or cell therapies, etc.).
- Product development via clinical trials.
- Sales and marketing.
REGN has succeeded in all three spheres with Eylea. This success could allow it to at least promote or co-promote a drug invented elsewhere, especially if that is done by a small company. The smaller the inventor, the more the company might need REGN to perform the clinical studies. Big Pharma/Big Biotech companies do this sort of thing as a routine; no analyst or sophisticated investor thinks twice. It's how they all roll.
Of the major biotechs, REGN currently invents and develops/co-develops everything in-house. That could change. REGN can definitely evolve to retain its retinal disease/eye disease franchise if it sees it will lose the Eylea franchise and does not have a better version developed in-house. I basically conclude that Eylea has very large profits ahead, that the Street is worried about it, and that REGN's prospects in ocular diseases might therefore surprise, over time, to the upside, and that the known issues with Eylea do not comprise a reason to stay away from REGN shares.
Next, a few comments on valuation, using GAAP and adjusted earnings, is necessary.
A look at potential 2019 EPS
In its Q4 earnings report, which I view as strong but which had several analytic complexities such as a negative tax rate and a one-time true-up payment from SNY, the company put forth partial guidance for 2019. Using the midpoints of the range, REGN projects GAAP expenses as follows:
- R&D: $1.93 B
- SG&A: $1.77 B.
These total $3.7 B, virtually unchanged from 2018. These understate cash flows, as they include the estimated value of stock-based compensation.
In addition, the two other major line items listed as expenses in the 10-K are not guided for. These are (p. F-5) cost of goods sold, or COGS; and cost of collaboration and contract manufacturing. I am going to guess at $200 MM and $300 MM, respectively.
Because "other income" has been negligible each year from 2015-7, I will ignore it.
Thus, my estimate of REGN's total pre-tax expenses for 2019 are $4.2 B.
The Street is at $7.4 B in revenue, of which REGN has guided for about $535 MM as GAAP SNY collaboration revenue. Note, the financial relationship between SNY and REGN is complex; neither P/S nor P/E are perfect in thinking about what REGN is worth. But I think that as a first approximation, GAAP EPS ends up being a reasonably good tool.
Because I'm bullish on Dupixent, I'm going to project $7.5 B in full-year revenues, leading to the following GAAP EPS estimates:
- revenues of $7.5 B,
- minus pre-tax expenses of $4.2 B,
- gives $3.3 B of pre-tax profit,
- subtract taxes at the guided rate of 15%,
- thus, after-tax profit = $3.3 B x 0.85,
- which equals $2.80 B,
- giving a 16.7X multiple using a $47 B diluted market cap,
- and giving GAAP EPS = $24.34.
This proposed EPS has some internal complexities, but what is more important to me than worrying about the GAAP treatment of monies flowing to REGN from SNY and back to SNY (which is of declining importance) is to consider the high proportion of revenues spent on R&D. What I routinely do to compare pharma companies to each other is adjust to a 15% R&D spend, which is about where Pfizer (PFE) and Merck (MRK) are. If REGN spends $1.93 B out of $7.5 B in revenues, that represents $805 MM in "extra" spending versus a 15% ratio. If that unspent monies became pre-tax income and was taxed at 15%, that would add $684 MM in after-tax profits, or an additional $5.95 EPS. That would bring adjusted EPS to $30.29, or a P/E of 13.4X.
The above would still be GAAP, but few US-based pharma companies promote GAAP EPS. All the big US pharma/biotech companies direct investors to focus on non-GAAP "earnings." So it's reasonable to think about REGN reporting as its peers and larger comparators do.
To make the above REGN estimates comparable to the way the mainstream financial media reports recent and 2019 projected EPS for PFE, MRK, J&J (JNJ) etc. would require an additional upward adjustment of several hundred million dollars of after-tax profit.
That could bring the R&D adjusted non-GAAP P/E to 12.5X or less, and would represent an apples-to-apples comparison to PFE and MRK; i.e. non-GAAP EPS compared with non-GAAP EPS, with the same percentage of revenues spent on R&D.
That's attractive in my view given that I view REGN as having large secular growth prospects, whereas for the most part, PFE/MRK/JNJ have to run hard just to grow a little bit.
If REGN meets my expectations and gets much larger, it might lower its percentage spend on R&D, either because it is running somewhat lower on growth ideas or, perhaps, because it knows that the private market value of its stock could be much higher than the stock trades for. It might, therefore, decide that the better use of cash is to spend less on R&D and begin to shrink its shares outstanding.
Whatever P/E one uses in thinking about REGN, and noting that the above are my working estimates and could be far from the way 2019 turns out, the question is whether REGN should trade at a discount to the 18X P/E the S&P 500 (SPY) is currently trading at based on S&P's compilation of about $150 consensus GAAP EPS for the S&P 500 for 2019.
A review of REGN's product and R&D trends leads me to favor an above-average P/E for REGN even with Eylea's uncertainties, which makes me suspect that REGN's private market value right now is much higher than $407 (but insiders likely have no interest in selling now).
Why REGN's recent growth spurt may just be a preview; focus on established products
In last week's conference call, founder and CEO Len Schleifer closed his prepared remarks by saying:
In summary, in 2018 we continue to build upon the foundation that we established over the last 30 years, which positions us for future continued success as an innovative biotechnology company... after 30 years all of us at Regeneron feel that we are just getting started.
REGN is no more than 7 years old as an important commercial entity. Its first drug, Arcalyst, was approved in 2008 for a very rare disease and never panned out as a treatment for commercially major diseases. Eylea, approved in November 2011, took some time to garner meaningful sales. Meanwhile, from what was therefore a standing start about 7 years ago, REGN has been pouring on the gas. Because Libtayo, its skin cancer immunotherapy (PD-1 inhibitor) developed with SNY, is so early in its life cycle, with much larger indications being sought, it's too soon to comment on it from a P&L standpoint.
Excluding Arcalyst, and understanding that Eylea is also, in IV form for colon cancer, marketed by SNY as Zaltrap, in essence REGN has developed 4 drugs that can be commented on:
- Eylea/Zaltrap (aflibercept)
- Praluent (for high cholesterol)
- Dupixent (allergic diseases)
- Kevzara (rheumatoid arthritis).
Eylea is amazing, and is a commercial mega-success because REGN saw more deeply than Roche about how to best treat key retinal diseases, i.e. with a dual-action "trap" rather than an antibody. We will just have to see how long and strong its run is in its different marketing territories. Note that Eylea has now demonstrated highly beneficial effects in the large and under-served market of non-proliferative diabetic retinopathy, so it is possible that its growth could reaccelerate as has happened to Revlimid and Humira despite being mature products.
Praluent is medically equivalent to Amgen's (AMGN) Repatha, and may finally be turning profitable for REGN. (I'm hoping the patent dispute may be settled; stay tuned.) Both SNY/REGN and AMGN overpriced these PCSK9 inhibitor antibodies, leading to pathetic product launches, but medically and scientifically, AMGN and REGN made significant contributions with their efforts. In contrast, while both PFE and Lilly (LLY) were very much in the hunt for the same target, PFE's product had to be withdrawn during Phase 3, and LLY was too late to the table to compete. In other words, REGN's next drug after Eylea demonstrated it could compete with AMGN and best PFE and LLY in what appeared at the time of launch to be a blockbuster or mega-blockbuster product category.
Dupixent demonstrates that Eylea was no fluke. As Eylea does, Dupixent cleverly incorporates a dual mode of action in one drug; with Dupixent, one antibody blocks two interleukins, IL-4 and IL-13. Extraordinary things can happen with Dupixent in appropriate patients, and there are many of them. By Q4, Dupixent sales in the US alone annualized above $1 B, with many more indications likely coming. Further, the pace of uptake accelerated even as the pool of available patients necessarily shrinks as more go on treatment. As REGN's head of commercial operations said in her prepared remarks:
There is a notable increase in Dupixent prescribing trends with weekly new-to-brand prescriptions... increasing to between 750 and 850 patients per week compared to approximately 500 to 600 per week in earlier quarters.
From about 550 to about 800 (? US only numbers) in a short time is very good news. Apparently, only a portion of that was due to the October approval for some forms of asthma.
Dupixent has an unusually high ratio of efficacy to safety. I'm comfortable with my long-held optimism that its sales will ramp to impressive levels even as new competitors enter against it. Remember, though, that REGN will garner somewhat less than 50% of global profits from this drug, as it is part of the non-renewed but ongoing SNY partnership.
Finally, Kevzara is indicated for RA and has other indications being pursued. Following Roche's Actemra, it is the second marketed antibody for RA that works by inhibiting the action of IL-6. Net product sales globally in Q4 were $35 MM, more than tripling yoy in the US and rising more than 6x in the rest of the world. With full-year sales under $75 MM, close to half of all sales occurred in Q4, suggesting good momentum. Kevzara has a 38% share of new-to-brand sales in its class, implying a 62% share for the well-known incumbent Actemra. Kevzara is doing well; it may never move REGN's needle a lot, but it's a nice achievement. By being second in the IL-6 blocking class after Roche, REGN has again beaten out some large competitors.
Kevzara continues the pattern that REGN began with Eylea of either developing best-/first-in-class drugs or else, second-in-class (Kevzara) with modest advantages over the innovator.
Next, how the pipeline may continue this tradition, but a larger and stronger REGN looks to be in control of 100% of the profits from drugs it invents going forward.
REGN's pipeline follows the tradition of the above products
REGN has a diversified pipeline that has some concentration in immuno-oncology, but that is almost agnostic to product category. All pipeline products are home-grown. REGN has two clear advantages in its pipeline. One is that its VelociSuite set of technologies allows it to develop and test all-human antibodies very quickly; time is money here. The other is that in my view REGN is led by scientific geniuses. I see no end to the inventiveness needed to solve important medical problems. I therefore will tend to expect that REGN is on to something big when, in his prepared remarks, R&D chief George Yancopoulos provided detail on a new type of bispecific antibody that he has been teasing for a few conference calls:
We recently announced that we're introducing to the clinic an entirely new class of bispecifics which we term costimulatory bispecifics. Compelling data in our animal models indicate that this new class of bispecific can enhance the anticancer benefit when combined with our PD-1 antibody [Libtayo] as well as with our CD3 class of bispecifics. This year we will be introducing two of these costimulatory bispecifics into the clinic.
Two new molecules, which apparently are first-in-class (or nearly so - it's a big R&D world) entering Phase 1 in the oncology field can lead to a shorter period to approval than usual if a product can demonstrate efficacy in Phase 2.
Dr. Yancopoulos continued, pointing out that although REGN's anti-PD-1 antibody Libtayo is the 6th anti-PD drug and 3rd anti-PD-1 drug (there are also three anti-PD-L1 drugs) on the market:
We entered the field of immuno-oncology with a long-term and comprehensive addition. We have created a large number of rational combination opportunities, enabled by the mixing and matching of our technology platforms and capabilities... and to supplement our internal efforts, we have collaborations and companies like bluebird [BLUE] that our therapeutic modality is potential synergistic with those that we have in-house.
I take all this as encouraging and representing excellent profit potential into the 2030s.
REGN is evolving away from partnerships as with SNY and BAYRY. It is gaining important expertise in marketing to oncologists in the US with Libtayo. Its I-O deal with SNY has been shrunk. I believe that along with SNY, REGN markets to allergists, dermatologists, pulmonologists, rheumatologists and as noted ophthalmologists in the US; and maybe still to cardiologists (Praluent). Thus REGN, from essentially being nowhere 7 years ago - with its Eylea launch of very dubious success both given the massive competition from Lucentis and off-label Avastin, and from the Roche lawsuit - has grown unusually rapidly into an R&D powerhouse, a skilled product developer and an increasingly knowledgeable US marketer.
That's pretty good for what in the drug biz is just a bit more than the blink of an eye!
No matter how smart the team at REGN is, it's all up to the unknowable future as to how its stock will, or will not, reward shareholders. Science-driven companies face the risk of losing their mojo. High-priced biologics are under pricing pressure. In addition, REGN is in a sense leaving its training wheels behind as it begins to emerge from the SNY partnership.
Please review the company's disclosure of its risks in its recent 10-K for a full review of the many ways REGN may falter.
Also, REGN has some complex relationships with SNY, as well as a less complex one with BAYRY. An investor in REGN may well wish to have at least a working knowledge of the principles that guide and control these relationships, both operationally and financially.
Concluding comments: What's the upside if the best is indeed yet to come?
Biotechnology (IBB) got a little frothy by late 2014 and into 2015. REGN got caught up in that excitement, peaking around $606 in August 2015. It spiked above $540 in June 2017, probably on excitement over the Dupixent launch. Now around $407, REGN is at a price it first reached in Q4 2014. Since then, it has co-launched with SNY the 4 innovative products discussed above, has grown its pipeline, and begun to move to truly independent status.
One low-profile Phase 3 failure for an RSV preventative and the weak launch of Praluent have marred matters, but continued sales growth for Eylea and prospects for further growth have been important positives. I suspect that the trio of Praluent, Kevzara and (especially) Dupixent are swinging from loss to profit, so that earnings may now ramp faster than sales. With capital spending requirements ramping down and the pipeline and marketing skills ramping up, I'm in no mood to micro-analyze REGN. It's generating lots of free cash, has a strong balance sheet, and I believe its valuation compares favorably with other innovative, secular growth names in the biotech and tech space.
In summary, I find REGN to be a cheap growth stock with very substantial upside potential on all relevant time frames. I compare its achievements the past several years with the best of global business and the very best of all of biotechnology in the entire history of biotech. As always with biotech stocks, volatility can be expected, risks from different directions are significant, and dividends may never be paid. REGN is therefore hardly a low-risk stock.
But, considering the above points and others I have made over the years about REGN, I have transitioned from trading an extended, hot stock in 2014-5, then an out-of-favor one last year, to now thinking of REGN as a growth-at-a-reasonable-price ("GARP") stock where over-trading can be hazardous to financial health.
Thanks for reading and sharing any comments you wish to contribute.
Submitted Sunday evening.
Disclosure: I am/we are long REGN. 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.