Amgen Dependence on Aranesp Off-Label Use Greatly Exaggerated

I touched on the issues Amgen (AMGN) is having with Aranesp a couple months back, but I decided to take a closer look at the numbers after the latest news that an FDA panel recommended further studies and label changes for the company’s anemia drug franchise. Such recommendations should not have been surprising given that a label change was already in the works (albeit less severe) and companies do follow-up studies on existing drugs all the time to measure long-term effects. Is the company going to lose as much business as Wall Street seems to be pricing in? I decided to take a look.

The main concern with Aranesp is that the drug is approved for patients with hemoglobin levels below 12. However, there is off-label usage going on at higher levels, and the FDA is concerned that such usage may increase cancer patients’ risk of developing other health problems. Amgen stock has been crushed on these

The media and Wall Street community has been focused on the fact that Amgen’s two anemia drugs, Aranesp and Epogen, represented 46% of the company’s sales in 2006. If you leave the analysis at that, then dramatic changes in prescription trends for both drugs would appear quite damaging. However, if you dig further to single out the areas of concern, you learn that Aranesp sales in the United States (where the FDA and label changes will have an impact) represent less than 20% of Amgen’s business. Recommendations for Epogen (which is used in dialysis patients) is not going to be known until later this year. Furthermore, off-label use is an extremely small percentage of total script volume, so even if Amgen loses all of that business, it won’t be catastrophic, as the chart shows (data courtesy of Amgen).

The FDA panel was focused on patients with chemotherapy-induced anemia (CIA) and anemia of cancer (AoC), and especially with off-label uses in those with hemoglobin levels above the targeted range of 11-12. As you can see, only 15% of Amgen’s sales in 2006 came from cancer patients taking Aranesp, and less than 3% came from off-label use.

Now, does this information warrant such a dramatic sell-off in the stock? It depends on how much business you assume Amgen is going to lose. If Aranesp revenue was going to go away all of the sudden, then yes, it would be very painful news for Amgen. But doctors are not going to stop prescribing the drug to most patients because the vast majority are using the

If we make some reasonable assumptions, not allowing Wall Street’s reaction to influence our thinking, we can come to a much more logical conclusion about Amgen’s future. Let’s assume Amgen loses all of its sales from off-label use. If the FDA issues similar recommendations for Epogen in the fall (which seems likely), that would result in a 5% hit to Amgen’s annual revenue. We can further assume that some on-label scripts will be lost due to some doctors getting nervous, combined with some who have borderline high hemoglobin levels and choose to cut back just to be safe.

Even if we assume that on-label sales drop off by a substantial 25% for both drugs (which seems like a high number to me), Amgen will see an overall sales drop of 10 to 15 percent. They would likely be able to offset some of that with cost-cutting, as they indicated they will do in their last quarterly conference call. The overall effect on earnings might only be 5-10 percent. Meanwhile, the stock is down nearly 30 percent, and may even be putting in a double bottom around $55 per share.

Full Disclosure: Long shares of Amgen at time of writing

Merck Does Investors a Favor

Shareholders in Merck (MRK) must be breathing a sigh of relief. An FDA panel voted 20-1 against approving Arcoxia, the company’s experimental arthritis pain killer, but the stock rallied $1.50 in after-hours trading Thursday night. Why such enthusiasm? Merck just happened to announce an increase in earnings guidance for 2007 right after news of the FDA committee’s decision hit the wires.

While many companies fail when it comes to looking out for investors, Merck deserves kudos for the timing of this announcement. An increase in 2007 guidance to $2.80 per share, versus current consensus estimates of $2.65 is more than enough to reverse the stock’s direction short term. Had the company waited until later in the month to announce the profit projections, the stock likely would have just recouped the losses suffered due to the FDA decision. Now, investors get a higher stock price despite the overwhelming angst over Arcoxia.

Now, one could argue that Arcoxia was not expected to be approved, so perhaps the stock would not have fallen very much. After all, the drug is a Cox-2 inhibitor, same class as Vioxx. However, by timing this announcement the way they did, at the very least it tells shareholders that the company does have its share price on the radar screen. That is a lot more than many public companies these days can say.

Should you go out and buy the stock hand over fist? That might be a bit extreme. Merck trades at 17 times the updated 2007 profit estimate. That seems about right to me. Throw in the 3.3% dividend yield and you have large cap stock that I would characterize as a solid hold, especially if the market’s jitters from last month come back later in the year, but not something you need to be throwing fresh money at all of the sudden.

Full Disclosure: No position

The Rising Cost of Healthcare Taken To Another Extreme

LOS ANGELES, March 26 (Reuters) – Shares of Alexion Pharmaceuticals Inc. (ALXN) rose more than 9 percent on Monday after the company told analysts that its treatment for a rare blood disorder would be priced at $389,000 per year.

The drug, Soliris, was approved earlier this month as the first product to treat paroxysmal nocturnal hemoglobinuria (PNH), a condition that affects fewer than 200,000 people in the United States.

“We considered many factors when establishing a price for Soliris. These included the rarity of this disabling and life threatening disease, the compelling clinical benefits that PNH patients experience with Soliris … the cost of discovery, development and production, and of ongoing research …,” David Keiser, the chief operating officer said on the call.

The company’s shares rose $3.71 to close at $43.78 on Nasdaq.

Imagine you are one of those approximately 200,000 people in the U.S. who have PNH. Finally, a drug has been approved by the FDA that may help you tremendously. You would likely be exuberant, for a little while anyway, until you learned how much the drug will cost. And that price is at the wholesale level.

This isn’t a political blog, so I’m not going to get into a discussion about what our country should do about healthcare costs that are spiraling out of control. No matter your view on the subject, investors should realize that until something changes, until a drug that is the first one approved to treat a condition doesn’t cost $389,000 per year, healthcare companies are probably going to have an easy time making money.

Some people won’t care, some people will be outraged and refuse to buy a stock like Alexion, and others will be outraged but will also separate their inner beliefs and politics from their investment strategy for the sake of reaching their financial goals. I have no opinion on the investment merit of Alexion stock, as I haven’t done work on it. It’s no shock though that it reacted well to this news.

Full Disclosure: No position in the company mentioned at the time of writing

Patient Investors: Take A Look at Amgen

As a value investor, it is often easier to find undiscovered or unloved stocks in the small and mid cap universe. After all, bigger companies are well known, followed by more analysts, and are very popular with retail investors. Those three factors lead to fairly high valuations more often than not within large caps. The tables have turned very quickly on Amgen shareholders. The stock hit a new yearly high in January of $78 per share. Since then though, they have seen a 25 percent haircut on several negative news events.


First, the FDA ordered the company to alter its warning label on Amgen’s lead products for Anemia, Aronesp and Epogen, in order to warn doctors and patients about increased risks when using the drugs for off-label uses. Investors are worried that Amgen could lose as much as 10% of their sales of these drugs if people currently using them in off-label doses cut back.


The current stock price seems to suggest that Amgen not only will lose a sizable chunk of Anemia franchise sales, but also will not be able to make that up with any new drugs. Although that seems to be very unlikely over the long term, even if we assume the company does not grow, and their profits level out at around their 2006 level of $3.90 per share, the stock seems to have little downside. This is not to say it can’t go lower in the next few weeks or months, but long term, I really can’t see a world-class biotech company like Amgen trade at much less than 14-15 times earnings.

That is not to say, however, that I shun large cap stocks all the time. If a bigger company has fallen upon hard times and is being beaten up by Wall Street, it often represents an excellent opportunity for a contrarian investment. Expanding on this theme, shares of Amgen (AMGN), the largest biotechnology company in the world, have been slammed in recent weeks and the stock is trading at valuations not seen in years, if ever.

There are also concerns about Amgen’s product pipeline, which many view as weaker than some other large cap biotechnology stocks. In fact, the company announced just last week that they stopped a clinical trial for one of their cancer drug candidates that they were testing in combination with Genentech’s Avastin and chemotherapy.

Despite the short-term setbacks for the company, Wall Street’s current valuation seems to be pricing in all of the negatives, giving very little chance that Amgen will be able to continue to grow. With the stock down $20 from its recent highs made earlier this year, the stock now trades at an astounding 14.9 times trailing earnings, cheaper than the S&P 500. As you can see from the chart below, biotech stocks traditionally trade at a premium to the market, and today is no exception, except for Amgen.

Obviously, a huge downward revision in earnings forecasts would make the current P/E outdated, but with a strong stock buyback in place, and the ability to make acquisitions to fill up their product pipeline (They bought Abgenix last year), an earnings collapse seems unlikely. Growth may slow, but the stock already reflects much, if not all, of that expectation.

If anything positive happens with the company, investors will likely realize fairly quickly that they became way too negative. With 25 drugs currently in development, the days of successful discoveries in Amgen’s laboratories shouldn’t be over by any means, but judging by the stock price, you’d think the company was on life support.

In cases like this when the market is assuming the worst, oftentimes it turns out that things will play out better than people are fearing. In my opinion, contrarian investors should consider adding Amgen to their list of stocks that warrant a closer look.

Full Disclosure: Long shares of AMGN at the time of writing

After Losing Caremark Bid, Will Express Scripts Target Medco Next?

Shares of Express Scripts (ESRX) have been on fire lately, rising 30% within months as the company tried to pry competitor Caremark Rx (CMX) from CVS (CVS). Somewhat surprisingly, ESRX shares have jumped to over $84 on news that the CVS deal was approved by shareholders, officially ending Express’ bid. With shares trading at 20 times 2007 earnings projections, the stock isn’t cheap. What might they do next to keep the share price humming along?

It appears they have three choices. They can remain independent, pair up with another pharmacy chain to match Caremark’s move, or do a vertical deal like the one they wanted to do with Caremark. In the latter case, the only big option out there is merging with Medco Health Solutions (MHS). While Medco has $5 billion more in annual sales than Caremark, a buyout would actually cost less, about $20 billion versus $27 billion. A partnership with Rite Aid (RAD) or Walgreens (WAG) would also be a good bet if ESRX feels they need to do something to remain on a level playing field with Caremark.

Given that they fought so hard to get Caremark, it would not surprise me at all if Express Scripts tried to get some sort of deal done. However, barring any accretive deal announcement, the stocks of the pharmacy benefit managers trade at 20 times current year earnings, which is at the high end of their typical trading range. As a result, they appear to be close to fully valued at current levels.

Full Disclosure: No positions in the companies mentioned at time of writing

Don’t Expect Express Scripts to Bow Out of Caremark Bidding

Pharmacy chain CVS (CVS) has increased its bid for Caremark (CMX) by $4 per share in an attempt to secure the pharmacy benefits manager. Rather than simply raise the per-share amount of its merger offer, CVS has chosen the unconventional route of sweetening its offer by promising a special dividend to Caremark holders should the deal go through. With CVS increasing the proposed special dividend to $6 from $2, their offer is now fairly comparable to the opposing cash and stock offer from rival Express Scripts (ESRX).

You may recall I already weighed in on this rare type of deal sweetener in January. I still believe offering a one-time special dividend to CMX holders is more like changing the deal terms from all-stock to cash and stock, since CMX shares will go down after a one-time large dividend is paid.

With the bids more similar now, I would expect Express Scripts to raise its offer shortly, perhaps as early as after the close today. They will not go the special dividend route. They want Caremark badly and realize that in order to convince Caremark holders to merge with a main competitor, and not a retail pharmacy, they will have to pay handsomely.

With consultants having already recommended investors reject the prior CVS offer, Express Scripts may very well land support for an increased bid, as they know that CVS is being very conservative with their special dividend strategy. All in all, I think Caremark prefers to do a horizontal merger with CVS, rather than a vertical integration with Express Scripts, but the offers must be at least comparable for such a move to survive a shareholder vote.

Full Disclosure: No positions in the companies mentioned

Caremark Investors Shouldn’t Get Too Excited About Sweetened CVS Bid

Shares of Caremark (CMX), a leading pharmacy benefits manager, are jumping today after the company received a sweetened takeover bid from drug store chain CVS Corp (CVS). Caremark has already agreed to a merger of equals with CVS in a stock deal worth 1.67 CVS shares, but arch rival Express Scripts (ESRX) has entered the mix by making a hostile cash and stock bid that is worth about $4 more per share (~$57 versus ~$53).

Worried that Caremark shareholders would vote against the agreed upon deal in its present form, CVS announced yesterday that it would pay a $2 special dividend after the deal closes. The financial press is reporting how this dividend closes the gap between the two outstanding offers (the ESRX offer worth about $57 is now only about $2 higher than the sweetened offer). However, it is correct to assume that this $2 special dividend really equates to a $2 increase in the CVS offer?

Let’s recall what happens when special dividends are issued. The stock price reflects the payout (which is a reduction of net asset value to the paying firm) and the stock trades lower by the amount of the dividend. This prevents arbitrage investors from buying company shares right before the record date and earning a $2 profit when the dividend is issued several weeks later. When cash is transferred from the corporation to the shareholder in the form of cash, the company’s shares are worth less and market forces reflect that.

Think back to the much talked about $3 special dividend Microsoft (MSFT) paid out in November 2004. Microsoft stock dropped from ~$30 to ~$27 after the payout. Investors do benefit by being able to cash out some of their position (assuming they don’t reinvest the dividend), but the shares aren’t worth any more by paying a dividend because the stock price reflects the payout right away by trading down in price afterwards. In fact, investors face a taxable event when special dividends are paid out, whereas they wouldn’t have if the money was kept in the company’s bank account.

If you own Caremark shares and are thinking about this CVS merger and how you would vote, consider that the newly added $2 special dividend really doesn’t cut the gap between the CVS and ESRX offer in half. It merely gives you some cash to go along with the 1.67 CVS shares you would receive in exchange for each Caremark share you own.

Full Disclosure: No position

Pfizer Boosts Dividend More Than Expected

Late Monday drug giant Pfizer (PFE) announced a 21 percent increase in its annual dividend, to $1.16 per share. With the stock trading at $25 and change, the new current yield on the stock is a whopping 4.5 percent. I speculated about two weeks ago that investors should expect a bump in the payout of 15 percent, so the magnitude of this increase is a positive surprise from my perspective.

The share price of PFE is unchanged on this news, but is it indeed an immaterial event? I believe value investors will add to positions in light of the more than 20 percent boost to the dividend. Pfizer’s yield should not be equal to that of long-term treasury bonds, and the market will likely correct this.

Assuming investors’ demand for PFE increases, I would expect the yield to fall back toward the 4 percent level. This would put the shares of Pfizer at $29 each, about 12 percent above current levels.

Full Disclosure: Peridot owns shares of Pfizer

Searching for Values in the Drug Stock Universe

In yesterday’s Pfizer piece I mentioned I had planned a broader look at the drug stocks, but focused only on the story du jour. Here are some thoughts on the sector that I wrote before the Pfizer news:

Not too long ago I wrote about pharmaceutical giant Pfizer (PFE) and how it trades at a seemingly steep discount to its peer group, and boasts a 3.9% dividend yield to boot. With the broad equity market having rallied sharply since August, investors looking to get a little more defensive can often find solid bets in the healthcare space. I decided to look at 12 of the larger drug companies to see if any other values are out there other than Pfizer. It appears there are.

I have actually been underweight healthcare stocks for some time. This had little to do with a lack of confidence in the macroeconomic outlook for the sector, and everything to do with the fact that I just couldn’t really find too many bargains. While many of the drug stocks still appear to be fully valued, sideways trading in several stocks in biotechnology has resulted in extreme price-earnings multiple compression.

Followers of the sector know very well that biotech stocks have traditionally traded at premiums to their big pharma counterparts, mainly due to the fact that they tend to be smaller, and therefore one big product breakthrough can have a dramatic effect on the company, and fuel substantially higher earnings growth. It appears in today’s market, however, that the two subsets of healthcare have converged as far as valuations go. As a result, I think there are opportunities for investors to capitalize.

Below you will see summaries of a dozen drug companies, sorted in ascending order of forward P/E ratio. Also included are current dividend yields and projected growth rates in 2007 for both sales and earnings. Grouping the names in this manner makes it a lot easier to spot the relative values.

In group “A” you will find the aforementioned Pfizer, which trades at a discount to its peers. Sanofi (SNY) is close, but yields about 50% less. Glaxo (GSK) rounds out the trio of below-market multiple stocks, but Pfizer still looks the best to me based on valuation and their dividend. Also, you may have read that the new CEO there recently decided to cut 20% of their salesforce. Further cost cutting is likely, and expect dividend increases to be consistent over time.

The second group of stocks (“B”) are those that trade around a market multiple. In this group, I highly favor Amgen (AMGN). I know they lack the 3-plus percent dividend of Eli Lilly (LLY) and Merck (MRK) but the double digit growth rates are very impressive, and AMGN has rarely traded at a sub-16 P/E.

Groups “C” and “D” are mostly biotechnology companies, but somehow both Bristol Myers (BMY) and Schering Plough (SGP) are trading at a premium to Genzyme (GENZ) and Biogen (BIIB) despite far less growth potential. Again, the fat dividend yields are a factor here, but I still believe there should be a valuation gap between biotechs growing at double digit rates and big pharma muddling around in the single digits.

Full Disclosure: Peridot owns shares of Pfizer and Amgen

Pfizer Setback Disappointing, Not Catastrophic

I was actually planning a broader pharmaceutical post today, but in light of the Pfizer (PFE) news over the weekend, I just wanted to talk about them a bit first. Peridot has a small holding in PFE, and will not be selling into today’s weakness. My bias would be to buy more, not sell. The news that the company is abandoning its lead cholesterol-fighting compound is obviously hardly a positive development. However, despite losing a key drug in its pipeline, the reasons I like Pfizer have not changed dramatically with this news.

Pfizer still trades at the lowest multiple in the big pharma group. Investors can certainly argue that such a price is warranted given the issues with their development pipeline, coupled with the fact that they are projecting flat revenues for 2007 and 2008. That said, once growth resumes in 2009 and beyond there will be outsized upside potential with such a depressed stock price. The bar will be set quite low when business begins to turn.

The stock is down more than 10 percent today to $24 per share. The current $0.96 annual dividend puts the stock’s yield at around 4 percent. I would expect a dividend increase to be forthcoming. A boost of 15% or more (to at least $1.10 per share) equates to a 4.6% yield, which is more than that of a 30-year U.S. treasury bond.

A floor on the stock due to the large dividend is not the only reason the shares are attractive at $24 each. Investors should expect accelerated cost cutting measures by management, increased share buybacks to appease upset investors, as well as an increased focus on M&A to boost their product pipeline. These moves will be largely received well on Wall Street, as they will allow the company’s earnings per share to hold up well (and even grow) for the next couple of years until new products can fuel larger growth in the drug business.

With the stock yielding 4 percent and trading at 12 times earnings, the downside for PFE is limited. Don’t get me wrong, this is a longer term play. The stock is not going to $30 overnight. However, the stock will pay you like a long-term bond while you wait for the picture to improve, and if some new blockbuster drugs do come to market over the next several years, there is no reason to think the stock could not reach the 40’s again. Add in the dividend payments and this defensive healthcare play could meaningfully boost portfolio returns over that time.

Full Disclosure: Long shares of PFE at time of writing