Amgen (AMGN) has been a very steady and impressive long term value creator in the biotechnology space, one which has seen quite a setback in its share price over the past week.

The reason for a near 8% fall in the time frame of just two days, while the market has seen a small rally, is that of some disappointing research results. Some success on this front is desperately needed to reignite growth, to thereby spark valuation multiple inflation.

The Results

Amgen and its partner Cytokinetics (CYTK) reported disappointing research results of GALACTIF-HF, a Phase 3 clinical trial of omecamtiv mecarbil for patients with heart failure with reduced ejection fraction.

Treatment of omecamtiv mecarbil met the primary efficacy endpoint and demonstrated a significant effect to reduce cardiovascular death or heart failure compared to the placebo. Unfortunately, no reduction in the secondary endpoint of cardiovascular death was observed, as this has been the trigger why investors were disappointed. Lack of efficacy severely limits the potential of the drug, even if it was approved. Note that the study was very large with more than 8,000 patients across 35 countries.

Both companies have started to collaborate nearly 15 years ago as the research outcomes are quite disappointing. Shares of Cytokinetics have essentially lost half their value over the past week, shedding about a billion in market value with shares now valued around a billion. Of course, Amgen is a lot more diversified and thereby hit far less than Cytokinetics. Nonetheless, the $20 move lower over the past week represents almost $12 billion in value being destroyed as a result of the disappointing research results.

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An Overview

Amgen has proven to be an excellent value creator over the past decade as sales have steadily risen from $15 billion to $23 billion over this period of time. Already fat operating margins have steadily expanded towards percentages in the 40s as the company reported operating earnings around $10 billion for a few years now. Nonetheless, it should be noted that sales growth and margin expansion has been much more limited in recent times.

These results are quite an achievement, as the improvements on a per share basis are far more pronounced after the company has retired nearly 40% of its shares over this period of time. This makes that revenues per share are up a factor of around 3 times.

The ”problem” is that shares have risen a factor of 5 times over the same period of time, up from about $50 a decade ago to essentially $250 in recent weeks. The long term gains achieved by the company are not just recognized by investors who have been bidding up the shares over the past decades, yet Amgen has obtained the prestigious honor to become part of the Dow Jones Industrial Average this summer as well.

For the year 2019 the company reported a 2% fall in sales to $23.4 billion on which the company reported adjusted net earnings of $9.0 billion and GAAP earnings of $7.8 billion, equivalent to about $15 and $13 per share, respectively.

Net debt has risen to $21 billion at the end of the year, although still quite manageable for a company the size and profitability of Amgen. Depending on which earnings metric you look at, shares trade at 16-19 times earnings. Investors furthermore liked the original guidance which called for sales at a midpoint of $25.3 billion and slight improvement in adjusted margins.

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Much of the anticipated growth has to come from Otezla which was acquired from Bristol-Myers (BMY). With this deal only closing on the 21st of November, the product added $178 million in sales for the period just over a month, or close to a $2 billion a year.

So far this year the company is delivering on its promises despite the impact of Covid-19 which had an impact on sales to a minor extent. While the company maintained the full year sales guidance, the company hiked the adjusted earnings guidance by $0.15-$0.25 per share, now seeing earnigns at levels close to $15.50 per share on an adjusted basis. One small concern, net debt has risen to $22.8 billion by now as the company will slow down the pace of share buybacks.

Otezla is generating sales at a run rate in excess of $2.2 billion by the second quarter and this is the driver behind reported sales growth. If not for this acquisition, product sales fell 4% in the quarterly period.

What Now?

With shares now down to $236, and using the adjusted earnings guidance for 2020, valuation multiples have fallen to 15-16 times earnings. There are some caveats however as dealmaking and aggressive buybacks pursued by Amgen makes that the company has incurred quite some net debt, with leverage ratios seen around 2 times. This is not a big concern, yet it limits the options for management to some extent. On the other hand, deals could always be (partially) financed with issuance of stock of course.

The real issue is that of organic improvements in topline sales rule stand for that one needs good research results eventually resulting into successful product launches. With Amgen having suffered a setback here, increased focus could be expected on the remaining part of its pipeline, and while this limits the near term reward, this might be reflected in the more modest valuations already.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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