Amgen: One Of The Few Bargains In This Market

Summary

• Amgen is an American biopharmaceutical company focusing especially on diseases in the field of oncology and hematology, inflammation or cardiovascular.
• The company has a wide economic moat based on its patents.
• The balance sheet is not perfect, but no reason to worry.
• Amgen seems to be undervalued at this point if we assume that Amgen can grow in the low-to-mid single digits.

I have covered several pharmaceutical companies in the past - like Celgene (acquired Bristol-Myers Squibb (BMY)), Novo Nordisk (NVO) or AbbVie (ABBV). And when I started to focus on wide economic moats, I was quite optimistic, that many pharmaceutical companies have a wide economic moat due to the various patents. And while this is certainly true for some pharmaceutical companies, it is not true for all - Gilead Sciences (GILD) might be an example where patents were no guarantee for growth in the last few years.

(Source: Amgen Multimedia)

In the following article, I will analyze yet another pharmaceutical company - Amgen, Inc. (NASDAQ:AMGN) - and we will try to determine if Amgen has a wide economic moat and if the stock could be a good long-term investment.

Business Description

Amgen is an American biopharmaceutical company, which was founded in 1980 in California as Applied Molecular Genetics and changed its name to Amgen in 1983. The company, which was once a biotechnology pioneer is today one of the world's leading biotechnology companies with $25 billion in revenue and about 22,000 employees. The company is focusing on areas of high unmet medical need - especially diseases in the field of oncology and hematology, inflammation or cardiovascular. Additionally, the company is also producing biosimilars and although it is only operating in one business segment - human therapeutics - Amgen is certainly diversified across several medical fields.

Amgen is present in approximately 100 countries all over the world, but 74% of its revenue is still generated in the United States. When looking at fiscal 2020, Amgen performed quite impressive - considering the global pandemic and recession. Revenue increased 8.8% YoY and non-GAAP earnings per share increased even 12.0% YoY. GAAP earnings per share on the other hand were not only much lower ($12.31 instead of $16.60), but also decreased about 4.4% compared to fiscal 2019.

(Source: Amgen Q4/2020 Investor Presentation)

Although Amgen is focusing on several different diseases, we can call its portfolio pretty concentrated. In fiscal 2020, the company had seven blockbusters each generating more than $1 billion in annual revenue (and these seven products generated about 66% of the company's total revenue). Four products even generated more than $2 billion in revenue:

• Enbrel is still the most important product as it generated $4,996 million in revenue in fiscal 2020 (more or less the same as in the last two years).
• Prolia generated $2,763 million in revenue in 2020 and revenue could increase in the last two years (in 2020 revenue increased 3.4% and in 2019 revenue increased 16.6%).
• Neulasta generated $2,293 million in revenue in 2020. The US patent already expired in October 2015, but due to the lack of competition the product remained unchallenged. In November 2019 the FDA approved a biosimilar from Novartis (NVS), which was a big hit for Amgen (in 2019, Neulasta generated $3,221 million in revenue and in 2018 it generated $4,475 million in revenue).
• Otezla generated $2,195 million in revenue in 2020 and this product is responsible for a big part of overall revenue growth in fiscal 2020. In 2019, the product generated only $178 million in revenue for Amgen as the company had bought the patents and rights to distribute and sell Otezla from Celgene (now part of Bristol-Myers Squibb) in November 2019 for $13.4 billion.

(Source: Amgen 2020 10-K)

Growth, Patents and Pipeline

I already mentioned above, that pharmaceutical companies are sometimes not the perfect wide moat companies as we are facing often a higher level of uncertainty than I would prefer due to the dependence on the company's pipeline, the expiration of patents and especially on competitor's ability to come up with a biosimilar. And Amgen certainly has patent protection for its most important products for many years to come.

(Source: Amgen 2020 10-K)

But when a patent expires, it does not automatically have to be a problem for a pharmaceutical company. Competitors also have to come up with biosimilars, which is not always the case and not always so easy as it might seem. And Amgen is not only dependent on how quick competitors can come up with biosimilars - it can also counterbalance the declining revenue from patent expiration with new products. And here the company's pipeline comes into play, which is extremely important when talking about the growth potential of a company.

I don't even want to pretend to have the medical expertise to assess the pipeline of Amgen. In this case, I have to rely on other experts and trust the peak sales predictions and what analysts are estimating for Amgen. When using earnings and revenue estimates according to Seeking Alpha we can assume that Amgen will be able to grow its revenue in the low-to-mid single digits in the years to come and offset losses by patent expirations. And aside from KYPROLIS approved for multiple myeloma by the FDA, Otezla being approved for Behcet's disease and RIABNI being approved by the FDA for non-Hodgkin's lymphoma, Amgen currently has 15 candidates, that are in phase III.

(Source: Amgen 2020 10-K)

Wide Economic Moat

And now, after we have talked about the company's patents, patent expiration as well as the pipeline, we can return to the question if Amgen has a wide economic moat or not. When I first started to focus on companies with a wide economic moat, I thought that pharmaceutical companies were pretty good picks due to the patents. This included companies like Gilead Sciences, which I am still holding and do not intend to sell, but which taught me a valuable lesson: just having a few patent-protected products is not enough to assume a business has a wide economic moat. Instead, we also have to look at the company's history and need proof, that management is able to constantly come up with new patent-protected products in order to justify an economic moat rating. Novo Nordisk would be a good example of a pharmaceutical company, that is also dependent on patents, but has proven again and again over several decades, that it can innovate and continue to grow at a high pace.

To answer the question, if Amgen has a wide economic moat, we can also look at several metrics, that usually indicate a "moaty" business. First of all, we can look at the company's margins - stability is good, increasing margins would be great. And the gross margin was more or less stable during the last decade and fluctuating around 80% (in 2020, it was a bit lower again). Operating margin was also lower in 2020, but in the years before it could improve.

(Source: Author's work based on numbers from Morningstar)

Aside from the gross and operating margin, return on invested capital is also a very important metric and during the last decade, ROIC was above 10% in every single year aside 2017. The average ROIC during the last decade was 12.84% and especially in the last three years, the ROIC was close to 20%, which is a very good and impressive number.

Amgen is also a cash generating powerhouse and while this is no proof that a company has an economic moat, these metrics are at least strong hints for the existence of a moat. During the last five years, Amgen only had to spend 6.6% of operating cash flow on capital expenditures (on average). This is an extremely low (and therefore great) ratio indicating that Amgen will generate a lot of free cash flow. And in the last five years, the free cash flow/sales ratio was 41.4% on average, which is another impressive metric and another hint, that Amgen is a cash generating powerhouse and probably has a wide economic moat.

Since 1988, Amgen only had to report a year-over-year revenue decline in three years (2009, 2018 and 2019), which is showing, that Amgen is not a "one-hit-wonder" but can generate stable growing revenue over decades and can replace products when patent protection is lost.

Considering the stable margins, the high return on invested capital and stable revenue growth over decades, we can be pretty certain about Amgen having a wide economic moat. The current patents will not only protect revenue in the coming years, but due to the solid pipeline we can also be confident that Amgen will stay innovative and introduce new patent-protected products.

Dividend

Amgen is also interesting for its dividend, which it started paying nine years ago and increased every single year since then. Recently, management announced another dividend increase and is now paying a quarterly dividend of $1.76 (10% dividend hike), which is resulting in a dividend yield of 3.1% right now. Over the last few years, Amgen also increased the payout ratio, which is now around 50%. But considering the extremely low capital expenditures we mentioned above, a payout ratio of 50% should not be a problem for Amgen and I assume management will maintain a similar payout ratio in the years to come.

(Source: Author's work based on numbers from Morningstar)

Aside from the dividend, Amgen also spent a lot of money on share buybacks during the last decade and between 2011 and 2020, the number of outstanding shares decreased by 35%. I also assume, that Amgen will continue repurchasing shares (as long as it can't use the generated cash in a better way).

Balance Sheet

If there is something to criticize about Amgen, it might be the balance sheet, which is far from perfect - but also not as terrible as it might look at first. The huge discrepancy between return on invested capital and return on equity (see chart above) is already indicating that Amgen has a lot of debt on its balance sheet. On December 31, 2020, the company had $91 million in short-term debt as well as $32,895 million in long-term debt on its balance sheet. When comparing the total debt to the total equity of $9,409 million, we get a debt-equity ratio of 3.5, which is a lot higher than we like to see. Additionally, we can compare the total debt to the operating income a business can generate. And we also have to consider, that Amgen has $10,647 million in cash and cash equivalents on its balance sheet. When subtracting this amount and assuming an operating income of $9 billion annually (conservative estimate considering the last few years), it would take about 2.5 years to repay the outstanding debt, which is acceptable.

We also have to mention $14,689 million in goodwill as well as $16,587 million in intangible assets. Having intangible assets is not untypical for biotech companies (patents for example) and is not a problem in itself, but goodwill is never good (although the name might suggest otherwise). Overall, the balance sheet is not perfect, but it should also be no reason not to invest in the business.

Intrinsic Value Calculation

So far, we have tried to get an understanding of the business and the picture of a solid company was presented. In order to determine if Amgen is also a good investment, we have to calculate an intrinsic value. As always, we use a discount cash flow analysis and therefore have to make some assumptions how much free cash flow Amgen can generate in the years to come. When looking at the company's own guidance for fiscal 2021, earnings per share are expected to be similar to 2020 and we therefore assume a similar free cash flow for 2021 as in 2020.

(Source: Amgen Q4/2020 Investor Presentation)

When trying to estimate what growth rates might be realistic in the years to come, it gets a little more difficult as revenue is dependent on many factors I mentioned above (introduction of biosimilars, pipeline, FDA approval of new products). Let's be cautious and assume 3% revenue growth for the years to come. This number seems not only realistic, when considering growth rates in the recent past, but is also in line with analysts' estimates (see above).

CAGR	Since 1988	Since 2000	Since 2010	Since 2015
Revenue	21.25%	10.18%	5.34%	3.42%
Net Income	29.78%	9.70%	4.60%	0.91%

Click to enlarge

When looking at these numbers, we can also see that bottom line growth (earnings per share) in the last few years stemmed from share buybacks. And we can assume, that Amgen will continue to buy back shares in the years to come, which might add another 2% growth to the bottom line and resulting in a realistic 5% growth rate until perpetuity. We could also assume, that Amgen might be able to improve its margins a little bit - especially net income margin can be improved if the company pays down debt. In 2020, interest expenses have been $1,262 million and without interest payments, Amgen could improve its bottom line almost 20%. But that is not an aspect I want to factor into the calculation. Instead, we use 5% growth, the free cash flow of 2020 as basis and a 10% discount rate, which leads to an intrinsic value of $335.22 for Amgen and the stock would be deeply undervalued.

Conclusion

It seems like Amgen is a real bargain at this point and the stock is trading with a 30% discount. While this sounds like good news it is making me a little uneasy as it reminds me of Gilead Sciences and me probably being once again too optimistic about the growth potential of a biotech company. Although I still hold on to GILD (and have no intention to sell), I could only collect dividends over the last few years, while the stock basically moved nowhere. I remain confident, that Gilead Sciences is undervalued at this point, but I don't want to repeat a similar mistake and buy into a company that has troubles growing.

On the other hand, we are buying a business, that is highly profitable and can generate a lot of free cash flow in the years to come. And even if my calculation is wrong, we have a 30% margin of safety protecting us even if the calculation was far off. And Amgen is also a recession-proof business - protecting us from potential turmoil in the coming years.

Analyst’s Disclosure: I am/we are long GILD, NVO. 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.