Monday, December 3, 2007

Amgen Valuation (AMGN)

Amgen (AMGN) is a well-established biotechnology, pharmaceutical company that is included in the NASDAQ 100. As I write its market capitalization is $59.8 billion. That is with a share price of $55.04. In the past 52 weeks its high has been $76.95 and the low has been $48.30.

For such large market capitalization stocks usually you can just look at the P/E ratio (price to earnings per share, which equals the ratio of market capitalization to net income) and get an idea idea of whether the stock is over or under valued. If revenues and earnings are growing rapidly the P/E should be higher than if growth is slow or stagnating.

Nasdaq lists Amgen's trailing P/E ratio (today's price divided by earnings per share from the past 4 reported quarters) as 13.17. Which inverts to a rate of return of 7.6%. That is real cheap for a famous biotechnology stock. So is it time to grab Amgen shares, or is something going on that urges caution even at this price?

Amgen has been hurt by questions about two of its blockbuster drugs, Arenesp and Epogen. Both drugs saw year-over-year revenue declines in the latest quarter. Both drugs are ESAs (Erythropoiesis Stimulating Agents), which means they cause red blood cell levels in the blood to increase. They are used to compensate for anemia induced by chemotherapy for cancer. The problem is that if the resulting hemoglobin level is kept too high, there appears to be increased risk of heart attack, stroke, blood clots, and accelerated tumor growth. This was not discovered during the clinical trials. When it was announced, naturally doctors cut back on using the drugs. (See also Amgen's November 8 press release).

Sales continue, and Amgen management says the medical consensus is that the risk from ESAs is far outweighed by their benefits. In addition, now that the risk is known doctors can monitor their patents' hemoglobin levels more closely. The economic problem with this is that with more cautious dosing, Amgen revenues from these drugs will be lower than they might have been otherwise. In addition some competing products may be causing pricing pressures.

Amgen markets other drugs besides Arenesp and Epogen. In Q3 2007 sales of Neulasta and Neupogen combined increased 10% from year-earlier. Enbrel sales were up 16%, Sensipar sales were up 47%. On the other hand Vectibix sales were down 9% due to unfavorable colorectal cancer evaluation results.

Amgen also has a large pipeline of potential drugs. See Amgen pipeline. Some of these may be the big revenue generators of future years.

Given that background, let's look at the Q3 numbers (See also my summary of the Q3 Amgen analyst conference). Revenue was $3.6 billion, flat from year earlier. Net income was $201 million, down 82% from year-earlier, giving EPS (earnings per share) of $0.18, down 81% from year-earlier.

The company has cash and equivalents of $5.95 billion, but debt of $11.3 billion.

Management says adjusted (non-GAAP) EPS for the full year 2007 will range from $4.13 to $4.23 per share. For Q3 it claimed non-GAAP net income was $1.18 billion, down only 4% from year-earlier and resulting in non-GAAP EPS of $1.08, which is actually up 4% from non-GAAP EPS of the year-earlier quarter.

So a big question is, do you go with the GAAP (Generally Accepted Accounting Princples) numbers or the much better non-GAAP numbers. Investors always argue that one both ways. The reason for the big difference a combination of a $590 million charge for acquired R&D expense from the Alantos and Ilypsa acquisitions, plus a $383 million in charges related to the ESA problem. There will be more charges for the ESA-induced restructuring in Q4.

So between the lower revenues for Epogen and Arenesp and increasing revenues for other products, if you are willing to ignore unusual charges, Amgen revenue and profit has been essentially flat for a year. If I thought it would be relatively flat I would want a return equating to a P/E ratio of about 12.

I think Amgen will return to revenue growth and net income growth in 2008, but I have to weigh in a substantial chance that the ESA problem will not be so easily resolved.

If revenue do turn up in 2008, I expect to see the P/E ratio return to something more normal, like 20. Of course if any of the pipeline drug candidates gets approved for a large market, Amgen could return to rapid growth.

All in all I would say Amgen is currently fairly valued to somewhat undervalued. I don't own Amgen stock, but if I were making a broader biotechnology portfolio I would not think it a big risk to buy some at today's price. Also, there are many other undervalued stocks in the market at this point in time due to the mortgage-market turmoil.

More data:

My Amgen Page
My biotechnology investor help page

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