Genentech Needs More Profit Power

Thankfully for Genentech (NYSE: DNA  ) , its own corner of the economy seems mostly recession-resistant. On Monday, the biotech reported another quarter of improving financials, despite ongoing tumult with the FDA and outside the biopharma sector.

Genentech reported yesterday that its first-quarter overall revenue rose nearly 8%. Its top drugs, including cancer treatments Avastin and Rituxan, posted blowout double-digit sales growth. Genentech's No. 3 drug, Herceptin, even eked out a small sales gain, despite registering almost no competition from GlaxoSmithKline's (NYSE: GSK  ) rival breast-cancer treatment Tykerb in the first quarter last year. (That disparity made comparisons between the two periods tough for Herceptin.)

Genentech's in-house Avastin sales now account for 20% of its revenue, so the drug's ultimate fortunes should have an outsized impact on Genentech's prospects. Earlier in the year, Genentech received a somewhat surprising accelerated FDA approval to market Avastin for breast cancer. Phase 3 studies currently under way should soon yield data that will further help decide Avastin's place in breast-cancer treatment.

Last week, Genentech told doctors that it found some safety issues in a phase 1 study testing Avastin in combination with Pfizer's (NYSE: PFE  ) Sutent as a treatment for solid tumors. There are literally hundreds of ongoing studies testing Avastin against all sorts of cancer indications; many will surely fall short, especially when Avastin is combined with another potent drug. The drug's failures in some settings are hardly ideal, but the more Genentech knows about where the drug is and is not effective, the more entrenched Avastin will become as one of the top cancer-fighting biopharmaceutical products.

While the company gets kudos for continuing to grow its top-line revenue, GAAP net income for the quarter only gained 4.7% year over year, and earnings rose only $0.03 per share, to $0.73. Drugmakers like Johnson and Johnson (NYSE: JNJ  ) , Wyeth (NYSE: WYE  ) and Eli Lilly (NYSE: LLY  ) have become such huge multibagger investments over the years largely because they managed to turn revenue gains into even larger gains in net income, thanks to the wonderful power of scaling profits. With its income growing much more slowly than its revenue, Genentech is experiencing the opposite effect right now. This will have to change in the future, lest investors eventually become unwilling to put up with Genentech's premium-priced valuation.

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Johnson and Johnson, Eli Lilly, Pfizer, and Glaxo are active Income Investor picks. Pfizer is also a recommendation of the Inside Value newsletter.

Fool contributor Brian Lawler does not own shares of any company mentioned in this article. The Fool has an A+ disclosure policy.

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