When it comes to assessing the outlook for drugmakers,
investors really only care about the pipeline of new drugs. After
all, existing drugs eventually losepatent protection, and when
that happens, a large hole in theincome statement can appear.
Just a few days ago, I looked at the prospects for traditional
drugmakers and concluded that
Bristol-Myers Squibb (
Eli Lilly (
are among the handful of Big Pharma firms with appealing
The renewed pipelines are in some instances giving thosestocks a
solid boost, withshares rising at an impressive pace over the
pastyear . But these stocks still can't keep up with the industry
upstarts: biotechnology firms.
These companies, which have emerged over the past few decades
tocapitalize on drug development through living organisms, have
posted even more stunninggains over the past 12 months. Look at
what these stocks have done in comparison with the 24% rise in
the S&P 500.
Of course, a sharply risingstock doesn't automatically equate
to anovervalued stock. How a company can sustain growth for the
next five to 10 years is what can justify furtherupside . And
that can only come from a broad base of clinical opportunities
that canyield multiple drug platforms.
Celgene (Nasdaq: CELG)
is a good example of such foundational platform building. The
company has four key drugs: Revlimid, Abraxane and Pomalyst for
cancer, and a newer drug, Apremilast, that is targeting
autoimmune diseases in clinical trials. Thatdiversification
explains why investors have pushed this stock up roughly 85%
since June 2012.
Back then, investors thought that a heavy reliance on Revlimid
(70% of projected 2013sales ) might lead to future vulnerability,
but management has made a strong case for the other drugs, which
should account for as much as half of sales by 2017.
Indeed, management's five-year plan helps explain why investors
see Celgene capable of eventually generating $12 billion in
annual sales by 2017. Equally important, these sales should carry
solid gross margins, so management expects operatingprofit
margins , which currently hover just under 50%, to hit 55% by
Yet as you start to dig into the other biotechs noted on the
table above, anote of caution emerges. Concerns include:
- Are investors andanalysts being too optimistic on the
chances for FDA approval of late-stage drugs in the
- Will these drugs, many of which will carry very high price
tags, face reimbursement pressures as health care dollars
- Can these companies, which only a year or two ago seemed to
have moribund pipelines, sustain the newfound pipeline momentum
that has many investors expecting a growth trajectory well
Gilead Sciences (Nasdaq: GILD)
neatly encapsulates these concerns. The company's strong
franchise of antiviral drugs targeting HIV and other viruses,
while respected, gave the company the appearance of a one-trick
pony. Yet Gilead's $11 billionacquisition of Pharmasset in
January 2012 gave the company access to Sofosbuvir, a promising
drug against hepatitis C.
Hepatitis C is a large globalmarket opportunity, and the two
current leading drugs on the market,
Vertex Pharmaceuticals' (Nasdaq: VRTX)
Victrelis, have been seen as interim but not ideal long-term
solutions. Those two generate roughly $1.2 billion in aggregated
Yet Gilead's Sofosbuvir has single-handedly changed the
expectations in the hepatitis C market. Tens of billions of
dollars inmarket value have been added in the past year, even
though this drug hasn't been approved. (Said another way,
Gilead's market value has increased at four times the rate for
the $11 billion purchase of Pharmasset.)
Even assuming eventual approval, investors still need to
question this drug's total opportunity, considering Gilead
intends to charge roughly $90,000 for an annual dosing. Recall
that this is the price that
Dendreon (Nasdaq: DNDN)
aimed to charge for its prostate cancer drug Provenge, which has
been a disappointment (perhaps due to that large price tag).
The Laws Of Bigness
In their zeal to bid up biotech stocks, investors need to
remember the key concern that has come to hamper Big Pharma
. Once a sales base becomes large enough, it gets harder to move
That's precisely the concern facing
Amgen (Nasdaq: AMGN)
. The company has five key drugs, which account for roughly $15
billion in annual sales. Still, sales grew less than 2% annually
from 2007 through 2011. A few new drugs have been added to the
mix recently, which should push the total sales base to around
$18 billion this year, but sales are projected to grow less than
5% in 2014 and 2015 due to a fairly thin late-stage pipeline.
So why is this stock up 46% over the past year? Management has
taken a cue from rivals and started to talk up the prospects of
the company's longer-term pipeline, and biotech investors are
eager to get their hands on anybusiness model in this industry.
Amgen may look like the bargain of this group, trading for just
four times projected 2015 sales, but that multiple is still
higher than those sported by its Big Pharma peers.
Risks to Consider:
As an upside risk, this industry is always busy withmerger
and acquisition activity, and industryconsolidation could take
any of these stocks higher.
Action to Take -->
Biotech stocks were generallyundervalued a year or two ago in the
context of those firms' clinical pipelines. Yet thatcatalyst is
now gone, and these companies are expected to deliver solid sales
for most of their drugs in phase II and III clinical trials. Will
these companies have a high hit rate with these drugs? Time will
The constrained health care spending environment, the potential
cannibalization of newly approved drugs on existing drug
franchises, and double-digit price-to-earnings ratios -- on 2015
projected profits -- means these stocks are now more vulnerable
to a pullback than they have been in quite some time.
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