Celgene Corp. (CELG)
Key Measures:
Recent Price: $95
52 Week Price Range: $93-$141
EPS: $2.06
Shares Outstanding: 775 million
Market Capitalization: $73 billion
Target Price: $125
Sell Price: $85
PE: 14
Biotech Has Been A Barking Dog
Biotechnology promises to change the fight against major diseases, remove pain and suffering, create high paying jobs and provide prosperity for business and investors. So far many of these promises have come to pass. Even more great health benefits are in store for the future. There is, however, one big thing missing.
For the past year, Biotech stocks have been absolute dogs. Take the SPDR S&P Biotech ETF (XBI: $50) as a proxy. In the last 12 months, it has fallen 38%. Just since the beginning of 2016 the decline has been 30%. How on earth could this have happened? After searching financial results, we could not find a problem with Biotech earnings; they aren’t collapsing. Most Biotechs are growing faster than the average company in the S&P 500. So we are in a quandary. Which means there is opportunity here.
In last week’s edition of Barron’s, there was a simple explanation in an article entitled, Biotech: It’s the Election, Silly. The author equated the rise of Hillary Clinton to the fall of Healthcare stocks. They might just have something there. When other investors can’t take the heat and it affects the normal judgment of others, this creates investment opportunities for us.
Why Celgene?
As a life mission, cancer has garnered more funds for research than any other cause known to mankind. Many of the drugs produced from these efforts focused on treating symptoms of the disease. After billions already spent, patients are living longer. Obviously this is a good thing. But commonly used treatments like radiation and chemotherapy are harsh and unpleasant for the patient. Very little drug research is curative. Immuno-Oncology, the science of fighting disease by stimulating one’s immune system holds the great promise of finding a better way to treat cancer and other major diseases. Celgene is seeking a cure and is far ahead of many other companies.
We are big fans of Celgene for several reasons. They are the third largest in the business of immuno-oncology. They have over 80% of their revenues coming from this source. Pharmaceutical giants Roche and Novartis are larger and more diversified. This gives them greater financial strength, but, they have less than half of their business in Biotechnology, so you get less bang for the investment buck. They are also both lumbering giants, with comparatively high stock valuations and slow growth. After reviewing the table below, you will get the picture very quickly. Wall Street projects Celgene earnings to grow 22% annually over the next five years. Celgene stock is sitting there waiting to be bought at only 16 times earnings. From this perspective, Celgene is an easy choice.
Top Five World Players in Oncology
One Trick Pony or Something More
The rub on Celgene in the past was its dependence on a limited product line. Indeed four drugs account for the majority of revenue: Revlimid at $6 billion, Pomalyst at $1 billion, Abraxane at $1 billion and Otezla at $1 billion.
Revlimid is used in Multiple Myeloma (cancer of blood plasma cells) as an alternative to stem cell transplants. The FDA first approved the drug in 2005 and it has been Celgene’s biggest engine of growth for the past decade. Through extended FDA approvals, patents on Revlimid are good to 2027. Product shipments are still chugging along at 15%-18% per year. However, there is no disguising the fact that, as drug growth cycles go, Revlimid is starting to get a bit long in the tooth.
In the past three years, Pomalyst has overtaken Revlimid as Celgene’s fastest growing drug. Approved for advanced cases of Multiple Myeloma in 2013, worldwide sales have more than tripled, reaching $1 billion at the end of last year.
There are two other important Celgene drugs. They are Abraxane (acquired in 2010), which is used in the treatment of three major categories of lung, breast and pancreatic cancers. And, Otezla - the leading drug for the treatment of psoriasis and psoriatic arthritis. Collectively this group contributes $9 billion of the $9.3 billion in revenues, (95%).
Celgene has the critical mass and focus to create major new biotechnology drugs. To accomplish this, $4 billion is invested in research and development, which is just huge. In recent years, the company has created five strategic alliances and made four acquisitions. This gives the company access to technology with breakthrough potential. At the present time, Celgene has 18 drugs in Phase III trials with the FDA. This is quite amazing no matter what size biotech company it is compared against.
In simplest terms Celgene is more than a one trick pony. It has a herd of racehorses with great potential. Here is a direct quote from the company’s recently published annual report:
“There are over 30 exciting and novel therapies in the early-to-mid-stage pipeline that represent our next wave of potential breakthroughs. Fueling the pipeline is an integrated, distributed R&D model that is designed to accelerate the pace of discovery and improve the efficiency of development. Taken together, we have the potential for over 50 new product approvals in more than 100 indications across the business, supporting our confidence in sustained growth past 2020.”
For the most complete details on all therapeutic categories under development, a look at the 2015 Celgene Annual Report is highly recommended. It does a great job describing in layman terms a highly complex scientific effort. Bravo management.
It is common for Wall Street analysts to dig through FDA submissions attempting to access the timing and potential of new drugs. Sometimes this works but we prefer to look at the sheer size of the new drug pipeline, especially the number in Phase III trials. We see potential written all over this company. We agree with the consensus that Celgene earnings growth in the years ahead will leave others like Roche, Novartus, AbbVie and Amgen in the dust.
Recent Results
In recent years, revenue growth at Celgene has averaged 20% per year paced by Pomalyst but with strong double-digit gains in all four main products. A close look at the bottom line shows that after a giant 38% increase in 2014 earnings, EPS fell 20% last year to $1.93. Ongoing business was outstanding. Gross profit margins are at a very high 95%. But this did not keep the bottom line from falling. There was a good reason for this.
Investment in research for the 18 drugs in Phase III trials rose 50% to $3.7 billion. This is money well spent and with so many at the Phase III level, we believe the new product pipeline will explode in the near future.
Guidance for 2016
Following a strong 1Q16 report, management revised upward guidance for revenue growth of 18% to $11 billion. This includes Revlimid sales gaining 16% to $6.7 billion. With major increases in R&D behind it, management expects to reach EPS of $5.60-$5.70. In all, this is a highly confident forecast that will make investors very pleased.
Balance Sheet
Celgene generates huge cash flow from operations - in excess of $2.5 billion annually. At the end of 1Q16, there was $5.7 billion in cash on the balance sheet, along with $14 billion in debt. Celgene does not pay a dividend. In addition to operating earnings growth, it plans to enhance shareholder value through repurchase of stock. The Board of Directors had authorized a $17.5 billion for this use. $10 billion was used prior to 2015; $3.2 billion was used last year leaving another $4 billion authorized. To fund this program, the company entered into a series of senior note agreements in 2015 totaling $8 billion at various rates of interest. They mature in five years or less and cash flow from operations is more than adequate for repayment.
BMR TAKE
We have great respect for the virtuous nature of Celgene’s business, searching for a cure to cancer. We get very excited at having the chance to invest in a stream of earnings growing 22% annually over the next few years and only having to pay 16 times for the privilege. Celgene is on the verge of something special and we want to be on board.