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Jelly Roll Capital Equity Research |
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Market Analysis, Education, and Wall Street-Quality Stock Reports |
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Market is Discounting the Potential of Biotech |
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Right now, two themes tend to dominate my stock selection: basic materials and healthcare; for the latter, specifically biotechnology. Here are a few stocks in that sector I like: Amgen (AMGN) is one of the largest and least loved of the biotechs, with shares trading near a two-and-a-half year low. The stock has been hurt by concerns over the safety of anemia drugs, along with Amgen’s Aranesp (which accounted for 27% of the most recent quarter’s sales) being considered for removal from a list of reimbursable drug purchases by Medicare. AMGN currently trades for 10x EBITDA and 15x free cash flow, but the bearish argument goes along the lines that the drug problems are going to impact earnings in such a negative way that the company is actually expensive, taking those future events into account. The specific questions raised by the United States F.D.A. center primarily on off-label usage of Aranesp in certain cancer patients - a market that amounts to less than 15% of Amgen’s revenues. Off-label use accounts for less than 5% of total revenues. Why all the selling? It seems like a classic case of ignoring the long-term favorable outlook to do a bit of panic selling on every questionable announcement, especially considering that Amgen probably has one of the world’s strongest clinical pipelines, not to mention all the resources it needs to bring new medicines to the market. With Denosumab (an osteoporosis drug) and Panutumumab (colorectal cancer treatment) in Phase III testing along with a myriad of drugs in earlier stages, Amgen seems to have excellent future growth avenues. The one problem I am having valuing AMGN is that it is difficult to assign a multiple, as the company has typically traded between 20x and 60x earnings. Regardless of where in that range the market eventually values the company, I have a feeling it will not be the 13x earnings the stock currently trades for. I see this as a rare opportunity where the collective twenty-something analysts that cover this stock have all simultaneously run away and have left an $85 stock in the garbage bin for under $55. Aspreva (ASPV) is a small Canadian biotech that derives its revenues from a licensing agreement with Roche for an off-label use of CellCept - more details can be found reading the report link. Right now ASPV is in the low $19s, which is approximately 10% above our cumulative discounted cash flow estimate for FY2007-2009; essentially, the market is pricing in almost no chance of Aspreva making another successful deal. Everyone who follows the stock knows that the announcement of a deal will send shares up, and I see Aspreva as being a 50% winner or more depending upon the ultimate success of whatever deal it commits to next. Exelixis (EXEL) is one of the most promising companies I have identified; this $1 billion biotech has partnerships with Bristol-Myers Squibb, Wyeth, and Genentech among others. With a drug pipeline that rivals that of industry leader Amgen (14 cancer-fighting compounds total) and a reputation for keeping research and development expenses under control while still delivering results on time, Exelixis would be my top pick for an exceptional growth stock. Recently, XL647 met a successful target in its Phase II testing for non-small-cell lung cancer, and that drug’s development seems likely to be taken over by GlaxoSmithKline in an upfront cash-and-royalty deal. Several other pipeline drugs conclude Phase II testing soon, and partnership dealings could bring Exelixis tens of millions or more in immediate cash payments and additional revenue streams from future sales, which would go a long way toward bolstering a balance sheet that already has hundreds of millions in net cash to continue funding its promising experiments. One additional interesting tidbit is that FMR (Fidelity Management and Research) owns 14.8%, and given that FMR will purchase up to 15% of the outstanding shares of stock in a company, EXEL obviously has the endorsement of one of the world’s top asset-management firms. PDL Biopharma (PDLI) is another interesting play in the biotech area, mainly because of some shareholder activism by Third Point hedge fund manager Dan Loeb, in addition to more recent words from PDL BioPharma founder Dr. Cary Queen. The very public actions of Loeb at Third Point is in response to a string of shareholder-unfriendly actions by CEO Mark McDade, including signing an extremely expensive new office lease, rejecting several Board of Directors candidates out-of-hand, and dismissing a $30+/share takeover offer without consideration. PDLI has been one of the worst-performing biotech stocks over the last several years, despite having lucrative licensing agreements with Genentech on the patents PDLI holds for antibody humanization - patents critical to the success of Genentech’s multi-billion dollar blockbuster cancer drugs Avastin and Herceptin. With 16% upside to the $30 minimum takeover offer amount - a gap that has narrowed thanks largely to Loeb’s involvement - I see further upside in PDLI. |