Saturday, December 22, 2007

2007 Wrap Up

This month and the first half of January 2008 I am working on a project for Microsoft; I have not had time to write blogs, though a lot of interesting things have happened with the stocks I cover. So here's a quick summary of 2007, recent events, and my thoughts on 2008 before I dive back into Windows Server 2008.

2007 was a good year for me, but not for my stock portfolio. Fortunately I resisted the temptation to try to flip houses in 2005-2006, which would have left me bankrupt. Instead I paid down my mortgage, which guarantees me about 5.5% in long term savings. So while my residence has declined in auction value, there is still a lot of net worth in it. I live in California, I've seen a couple of downturns, and as they say, you can't make new real estate near the ocean. So I'm not worried. My apple trees brought in a good crop this year, and that is a good metaphor for how I think about investing. I planted the first ones 9 years ago and now just about all I have to do is water them 4 times each summer and I get top-quality organic apples to eat or trade. The best investments may require a long time frame.

My portfolio is another matter. It was an evil year for me; I did worse than the market. There were two major killers: AMD and Marvell (MRVL).

AMD had just introduced Opterons when I made my initial investment. It looked like an Intel killer for a while. Then it bought ATI at the same time Intel tried to crush it with a price war, resulting in a string of net losses. In 2007 the quad-core Barcellona Opterons were supposed to save the day, but they never came. Now AMD says Q1 2008; we'll see. On the other hand the law suit against Intel is probably worth more than AMD's entire market capitalization today. But lawyers, judges and juries are a tricky thing. Intel was caught red handed, but will hide behind their lawyers as long as they can.

Marvell has been a profitless wonder story, which is alright with me. In 2006 they acquired Intel's mobile processor division. The costs from that and heavy investment in research has meant GAAP (and even some non-GAAP) net losses. But revenues have climbed rapidly, and Marvell management says revenues will continue to climb in 2008, but promises to hold research costs steady. Today's bargain stock price will seem cheap if management delivers on that promise. If they screw up, or if the macroeconomic picture gets worse, then the price could fall further.

The massive stupidity of both lenders and real estate investors is creating turmoil that can benefit those who were more conservative and have cash to spend. Most (but not all) stocks are cheap right now. Real estate varies by geographic area; I would not call it cheap, but low ball a house you like and chances are the owner will bargain with you. The global economy is strong with a few weak spots, but that it as usual. Agriculture is strong; land prices in Iowa and other grain-production area are actually rising. Note that sovereign investment funds are jumping in to use cash to buy U.S. assets. They may make some mistakes, but I think foreign investors will see the value in U.S. assets (stocks, bonds, and real estate) first because the dollar is weak and they can be less emotional from a distance.

The main economic problem for the U.S. is the Republican Party's "No New Taxes" pledge. It has been good for partisan politics, but bad for the nation's economy. There is still plenty of government waste, and imperialistic adventures are bleeding the U.S. dry. But mainly low taxes are the cause of the deficit. Pay now or pay more later is a rule for taxpayers. Say half the Bush tax cuts for the wealthy were eliminated. Couldn't the billionaires live with that? They'd still be paying lower tax rates than at any time since World War II, but the deficit could be eliminated and there might even be some money for infrastructure that is not Congressionally earmarked crud.

One last note: Celgene (CELG). Boy, did I think I was smart to buy this company earlier this year. Then they announced an expensive merger. Okay, I could live with that. Recently there has been speculation that a rival will cut into their Revlimid franchise. Ouch! I can't decide whether to buy more stock because it is cheap or to be cautious here.

My best stock in 2007: Microsoft (MSFT). Despite all the mud slung at it, it does a number of things way better than any of its competitors. Internet bandwidths are just not sufficient to allow serious office productivity to run on the Internet. After years of Google hype, when you look at Google numbers, all its revenues come from ad sales. That is great, it is a great, profitable, and useful company (this blog is run on Google). But it is little or no threat to Microsoft's core business, or Adobe's for that matter. Modern PCs are supercomputers; those who know how to use this amazing tool can run circles around those who use them as glorified typewriters.

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