The Best Blue Chip for 2007: Amgen

I can't help but reminisce about Amgen (NASDAQ:AMGN) as a fast-growing "Rule Breaker," the poster child for a biotechnology industry still struggling to prove it could do something other than swallow up stunning amounts of equity capital. Why, just last century (in December 1998, that is), Amgen was added to The Motley Fool's original online Rule Breakers portfolio, and from then until now it has racked up returns at a CAGR of 19%.

But the story has changed, and Amgen has grown up. By market cap, it is bigger than Big Pharma companies like Bristol-Myers Squibb or Wyeth, which have pedigrees stretching back 120 years or more. And its stock, from last September up until the market rally that began this past August, has been a picture of slow decline. Despite recent gains, it's still more than 10% off its 52-week high.

That's exactly why I think that Amgen -- no longer a Rule Breaker per se, but still part of a dynamic, fast-growing industry -- is the blue chip to watch. There's a lot to like about this company:

1. It's on pace to exceed $14 billion in total revenues this year, with .
2. . gross margins topping 85%, and .
3. . estimated 2006 earnings of $3.93 per share before option expenses, as well as .
4. . $4 billion in free cash flow.

It would have even more cash if it hadn't bought back almost $5 billion of its own stock so far this year.

Investing in the future
But the real reason Amgen attracts my interest right now is more cyclical in nature. Not cyclical in terms of the economy (although drug stocks are a traditional haven in times of weakness), but cyclical in terms of innovation. All drug companies count on their pipeline to drive future growth, but innovation is an unsteady business. After years in which many investors complained about a lack of new products, Amgen is entering a fertile period.

In the most recent quarter, Amgen reported a 29% sequential and 49% year-over-year surge in R&D spending -- a reflection of the fact that it is supporting its maturing pipeline with nine ongoing "mega-trials." It expects that trend to continue next quarter, too. While some investors might see the increased spending as cash taken from the bottom line, I think it is a favorable sign of things to come.

Repeating history
Consider that in mid-2003, Genentech (NYSE:DNA) had an aging stable of products, heavy R&D spending (it sank 24.1% of revenues into R&D in 2002), and was relying heavily on its pipeline to fuel future growth. Analysts worried that too much was riding on the uncertain outcome of clinical trials. But as Fools know, the best time to buy a strong, well-managed company is when it looks weakest.

Over the subsequent three years, Genentech went on an incredibly productive run, winning approval for Avastin, Xolair, Tarceva, Raptiva, and Lucentis. From May 16, 2003 (right before the company announced positive phase 3 results for Avastin) to the present, the stock has gained 304% (that's a CAGR of about 51%).

Now here's where Amgen compares to its peers. Like Genentech in 2003, it's currently churning a lot more of its revenue back into innovation, and starting from a much stronger position in terms of cash, revenues, and income than Genentech could ever boast.

Foolish bottom line
I'm not saying that Amgen is on the cusp of an equivalent perfect storm of potential blockbuster products, but it does have some new and near-term products that should allay investors' fears about potential generic competition to Epogen and Neupogen. One, certainly, is Vectibix, a recently approved competitor to ImClone's (NASDAQ:IMCL) Erbitux that Amgen developed in conjunction with antibody powerhouse Abgenix (which it subsequently acquired, along with that company's pipeline and expertise). Denosumab, a monoclonal antibody that targets a receptor involved in bone remodeling, is in phase 3 for both osteoporosis and certain cancers involving bone metastases, and may have other indications as well. It should hit the market in the 2008-2009 time frame. And Amgen's early-stage pipeline is looking stronger than it has in years.

Perhaps just as importantly, Amgen's approach to innovation is evolving. Two years ago, it finally did what some of its Big Pharma brethren have been doing for years -- it became a venture capitalist. Amgen Ventures, set up with an initial $100 million, has made five investments so far. In October, it bought Avidia, a private company working on a new class of "avimer" proteins that could potentially supplant monoclonal antibodies one day. That's a great way for a solid blue chip to nurture its Rule Breaker roots.

If you agree with that position and consider Amgen a great stock, let us know in our brand-new Motley Fool CAPS community intelligence database by rating Amgen an "outperform." And if you disagree, go ahead and rate it an "underperform." Our goal is to harness the power of individual investors to help determine the best blue chip for 2007. You can help by joining CAPS and offering your thoughts. Just click here to get started.

To read about the rest of our blue-chip candidates, click here.

Fool contributor Karl Thiel does not own shares in any company mentioned in this article. Merck was once a pick of the Motley Fool Income Investor service. The Fool is investors writing for investors.