Profit-Taking Time for This Drug Stock

02/28/2012 9:30 am EST

Focus: STOCKS

Paul Larson

Editor, Morningstar StockInvestor

Use this opportunity to step out of this stock while it's in rally mode, and if you want exposure in the sector, put your money to use in one of its rivals, writes Paul Larson of Morningstar StockInvestor.

Amgen (AMGN) is a company that has been in the Hare portfolio since 2002, and it has had a rocky tenure.

Instead of being a relatively steady firm, safety concerns arose for Amgen’s main anemia drugs, which was unusual because they came after the drugs had spent several years on the market. We also saw government reim­bursement pressures create a major headwind for the business.

Amgen is still a solid firm, but it is far from being the best of the best in the health-care sector. However, in recent weeks the stock has run up to near our $68 fair-value estimate, following a large share buyback and some excitement about the new CEO, even though these factors do not fundamentally improve the business. As such, it made the most sense to make room in the portfolio by bidding these shares “adieu.”

One question I commonly receive is, “Why didn’t you wait until it hit the ‘consider sell’ price before cutting the position?”
While I would most certainly sell at first chance a dollar bill trading for $1.35 (a 35% premium to fair value), I can also add value to the portfolio by selling dollar bills for $1 to recycle the capital back into other dollar bills that currently trade at, say, 70 cents.

My strategy with the Tortoise and Hare is to minimize the dollar-weighted price/fair-value ratio of the portfolios while maximizing the dollar-weighted star ratings. The trades I made in January furthered both of these goals.

About Amgen and Its Valuation
Thanks to the promise of Prolia/Xgeva, we think Amgen is capable of maintaining its top line and supporting mid-single-digit bottom-line growth for the next five years in spite of the long list of challenges facing its established portfolio of drugs. Amgen’s anemia drugs, Epogen and Aranesp, continue to see pressure from tougher labels and reimbursement.

Patents on all five of Amgen’s blockbusters begin to expire by 2015, making the firm a prime target for companies developing biosimilars, including Merck (MRK) and Teva (TEVA). While Amgen is flush with cash to pour into R&D and acquisitions, our enthu­siasm is tempered by a late-stage pipeline that’s heavily reliant on a handful of high-risk cancer drug candidates.

For example, motesanib recently failed after being held up in Phase III trials for years due to safety issues. New Phase III candidate AMG 386 could face stiff competition from Roches (RHHBY) Avastin in ovarian cancer.

We raised our fair-value estimate for Amgen to $68 per share from $65, based largely on the expected reduction in the number of shares following the $5 billion tender offer in December 2011.

We expect combined sales of Prolia/Xgeva to peak at $5 billion, with more than $3 billion from Xgeva alone. Pressure on sales of erythropoiesis-stimulating agents (ESAs) has continued into 2011, and ESA sales growth should remain in negative territory for the foreseeable future.

We anticipate generic competition to Epogen in the US by 2013, and Aranesp as early as 2015. Sales growth from Prolia/Xgeva—and to a lesser extent Nplate—should largely neutralize this pressure on top-line sales, and we model flat sales during the next five years.

We assume that Amgen’s 39% oper­ating margin (excluding amortization expense) should decline by about 300 basis points during the next ten years, as a smaller percentage of sales will stem from older, more profitable biologics.

We don’t believe that improved efficiency, cost-saving measures, and the end of Enbrel profit sharing with Pfizer (PFE) will be able to counter pressure from biosimilars. During the next five years, our earnings per share growth rate averages 6%, largely due to continued share repurchases.

We model a 70% probability of approval for Prolia to delay the development of bone metas­tases in 2012, an indication that could be worth roughly $1.9 billion of our $5 billion assumed peak sales potential of Prolia/Xgeva.

Subscribe to Morningstar StockInvestor here...

Related Reading:

Tyco, Better Off Dead

An Odd Couple with Lots of Headroom

A 100% Institution-Focused Stock

Related Articles on STOCKS