Dueling Fools
I Am What I Amgen
Bear Argument
By
Like any right-thinking person, I'm very impressed by what Amgen has accomplished. But, seemingly unlike the market, my admiration has coherent limits. With growth rates of somewhere around 15% and a trailing P/E ratio of over 45, it doesn't take a whole lot of time to see that shares of Amgen are a wee bit too expensive at today's price. Put another way -- and I'll just place this one right in front of my Dueling opponent -- name the other companies that you love that aren't growing sales by even 15% annually and yet go at such a high P/E multiple. I'll wait patiently.
Granted, the "Price matters, dammit" argument might seem to be a dodge to those accustomed to thinking that any company that can be shoehorned into a "Rule Breaker" categorization is exempt from having to justify its price by standard valuation metrics. I humbly beg to differ with such an interpretation, at least as applied to this company. Amgen, though held by the Rule Breaker portfolio, is confined by an awful lot of well-established rules -- the two most powerful being the rule of averages, and the rules of the FDA. It's pretty evident from Amgen's fairly lengthy past that it is indeed constrained by them.
Amgen has been around for 20 years now, so that's enough of a history to draw some concrete conclusions. The company has two (count them, two) major products -- Epogen and Neupogen. (Amgen has a third drug, Infergen, that provides less than blockbuster sales.) I could make a big deal out of the competition that the legal case involving Transkaryotic Therapies <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TKTX)") else Response.Write("(Nasdaq: TKTX)") end if %> poses to Epogen, or of how the continually revised rules of Medicare reimbursement might affect Epogen and Neupogen. But I won't go into a litany of specific bugaboos that might happen, just as I would recommend that readers not buy into the upside prognostications of what might happen.
This company is involved in so many lawsuits regarding patents, has so many drugs in its pipeline passing and then failing different stages of regulatory approval, and is constantly facing threats from so many competing drugs that the number of specific variables in any given year measure in the dozens, if not hundreds. And over the course of time, the good and bad things that can and do happen translate through the rule of averages into a reasonably consistent improvement of maybe 13% or 14% a year in sales. They have in the past, and they are expected to in the future. (EPS growth has been slightly higher over the last three or five years, though that is due almost entirely to a share buyback executed when the price of the shares was significantly lower than what is available today.)
What could radically change that growth percentage number? I'm going to assume that Paul has recognized in his bull argument that Amgen's future is its drug pipeline, which has some impressive-sounding drugs. But how many of those drugs actually will make it to market? Let's look at the rule of averages: According to Hoover's Online Biotechnology Industry snapshot, only one in 10,000 drugs makes it to the market. Now, I'm sure that Paul listed more than one potential drug in the Amgen pipeline, but did he list 10,000? (I hope not, or else he's gone well over his word limit for this piece.) If he didn't, consider the rule of averages, and consider whether Amgen is a breaker of that rule; it's been eight years since Amgen has had a major new drug come to market.
And that's because Amgen operates in an industry that is more burdened with rules than any other that I can name. The FDA, for good and ill, has an extraordinarily labyrinthine procedure for getting drugs approved, and the average length of time from creation of a drug to marketing it is 10 to 15 years. To the extent that you're thinking that Amgen must be on the verge of getting a new major drug approved, all I can say is that the company had better be. The patents on Epogen begin to run out in 2004, and on Neupogen in 2006. As soon as those dates hit, you can say good-bye to Amgen's days of selling drugs at a 90% gross margin.
Reflecting these realities, Amgen historically has traded at a pretty steady P/E that reflects its earnings power and growth. Between 1992 and the end of last year, Amgen never traded at higher than 33x its current year's earnings, and typically closer to 20x. Suddenly, however, shares of Amgen go for about 50% more than their previous highest multiple, and about double their typical one. The last time euphoria got that high for Amgen was in 1991, and the company's market cap didn't get back to its end-of-1991 price until 1995 -- despite steady sales and profit expansion throughout those years.
Is there something that has been going on this year with the company to account for its excessive price? Hardly. While it's been an absolutely spectacular 12 months for the stock price of Amgen, the same is true for the stock price of virtually every other biotech stock. Take a look at this comparison chart of Amgen with Cephalon <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CEPH)") else Response.Write("(Nasdaq: CEPH)") end if %>, Biogen <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BGEN)") else Response.Write("(Nasdaq: BGEN)") end if %>, Immunex <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: IMNX)") else Response.Write("(Nasdaq: IMNX)") end if %>, Medimmune <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MEDI)") else Response.Write("(Nasdaq: MEDI)") end if %>, and IDEC Pharmaceuticals <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: IDPH)") else Response.Write("(Nasdaq: IDPH)") end if %>; pretty much every major biotech stock's price has increased by more than 100% -- with a couple of them up substantially more. Investors have simply bid up the sector en masse.
Such behavior is typical for the manic-depressive biotech sector, which has a well-known history of cyclicality between extreme investor enthusiasm and despair. Today, you can buy Amgen at the very peak of that cycle. Be my guest, but unless the rules are really broken, keep in mind that it won't work out well for you.
Next: The Bull Responds