Valuing biotech stocks can be more difficult than valuing other industries. Share prices in top-tier biotech companies like Celgene Corp. (NASDAQ:CELG) and Biogen, Inc. (NASDAQ:BIIB) pop and drop not only because of sales and profit trends, but also because of the latest news regarding clinical trials of next-generation drugs.
Because medicines on the market ultimately face patent expiration and drugs in pipelines can have a big influence on share price, deciding to buy a biotech solely because of its price-to-earnings ratio may not be the best bet.
In this episode of The Motley Fool's Industry Focus: Healthcare podcast, Kristine Harjes is joined by Todd Campbell to discuss Biogen's and Celgene's product and pipeline puts and takes and to find out which of these two Goliaths is a better buy.
In addition to discussing those two companies, the duo also dives into Gilead Sciences' (NASDAQ:GILD) latest drug, Epclusa, to see whether its recent approval makes Gilead Sciences' shares a bargain-bin buy. Can Gilead Sciences position this hepatitis C game-changer so that it takes market share away from competitors, rather than from itself? Find out more in the following video.
A full transcript follows the video.
This podcast was recorded on Jul. 1, 2016.
Kristine Harjes: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's July 6th, and I'm your host, Kristine Harjes. Healthcare contributor Todd Campbell is calling in, as usual. Welcome to the show, Todd!
Todd Campbell: Hi, Kristine!
Harjes: How's it going?
Campbell: It's going well, thanks.
Harjes: I'm going to make the disclaimer before we get into the show that we are prerecording this episode, so it's actually last Friday. It's July ... That's a weird phrase to say, but it is July 1st when we're recording, and a lot of the things that we're going to touch on today involve prices, and prices, as we know, move -- so the numbers that you hear on the show today are reflective of Friday, July 1st.
First thing that we wanted to talk about: We got a really interesting question from a listener. Doran Pellad from New York City asks, as a followup to our May 11th show on better-buy battles -- we talked about Celgene and Biogen. And Doran wrote in asking whether Celgene is really a better investment at this time, seeing as how Celgene's pricing seems to reflect its potential already -- meaning that it could be more susceptible to a larger decline, in case there is a problem with one or more of their future products. And he contrasts that with Biogen, which is cheaper, but could have more upside if one of their moonshots comes through.
As I mentioned, we talked about this on May 11th. We've also talked about Biogen since then, on June 8th. We covered the failure of one of their key drugs. Todd said it's still a buy after that; the stock took quite a hit. I disagreed. Where do we stand now on Celgene versus Biogen, Todd?
Campbell: First off, let's just start by saying: Awesome! I love it when our listeners chime in and ask us questions, and then we can give them feedback. That's fantastic!
Harjes: That's great to know what's on your mind!
Campbell: Yeah. I think it's great because it gives us an opportunity to talk about two companies that are very popular with investors in biotechnology. It contrasts them against one another, and really dives into, "Okay, if I only have so much money to invest, where do I invest it? If I can't tuck in two different biotechs, and I can only tuck in one, should I be looking at the beaten-up one, Biogen, or should I be looking at one maybe that's less beaten up, Celgene?" The listener mentioned things like P ratios and trying to determine valuation, and then he was speculating: "Well, what if these things that are in the pipeline pan out?" I always, always, always come back in biotechnology to the three P's: product, pipeline, and profit. Those are the three things that you're going to want to be looking at when you're evaluating these two companies, and any other company in the industry.
Harjes: Right. It's one thing to say that they're both good buys, and "Look at the three P's," but to be able to actually pick one as the better buy, that's pretty important when you're taking action and trying to build a portfolio. Let's talk a little bit about those P/E ratios, as followup to the last episodes. I mentioned that Biogen has gone down pretty substantially, and it looks like it's trading quite cheaply right now. Do you have a --
Campbell: Both of these stocks aren't "expensive." I mean, theoretically, historically I should say, biotechnology stocks get a premium from investors because they're working on game-changing medicines and the risk/reward is quite high. I mean, those medicines could fail in clinical trials, or they could go on to become multibillion-dollar blockbusters. A lot of times, especially obviously with clinical-stage biotechs, you focus less attention on the P/E ratio, because there's no E to measure. That's not the case, obviously, with Biogen and Celgene, because they've been around a long time, and they both already have really, really strong product franchises that are racking up billions of dollars in sales, and they're leveraging that to generate out big earnings by share. So yes, you have a situation where you've got Biogen trading at about 15 times trailing 12-month earnings. You've got Celgene trailing about 49 times trailing 12-month earnings. But before you draw any conclusions from that, I want to remind other listeners that the stock market is a forward-looking instrument. I tend to focus more attention on the future P/E ratio than I do the past P/E ratio.
Harjes: Yeah, that is a great point. Celgene's actually really helpful in their forward guidance. They actually say that "By 2020, this is what we're expecting," and those numbers are $13 a share in EPS, which, that's a pretty substantial boost. That would mean that the stock is trading today at 7.6 times that number for today's prices. In general, Celgene has historically traded pretty richly. Over the past three years or so, the average forward-looking P/E for the company was over 20, and today it stands at just under 17. It has been on the decline for years. It might be --
Campbell: I was looking at numbers today earlier, Kristine, too, and the numbers that I was sourcing out showed a future P/E over the next 12 months for Biogen of about 12 and for Celgene a little north of 14. In my view, that's not a big difference between the two. Historically, like you said, Celgene trades a little richer, but there's a reason for that. It's been growing more quickly.
Harjes: That is true. When you look at the growth numbers for these two, it does look like Celgene is positioned for more growth.
Campbell: Right. 20.7% year-over-year growth, using the last quarter on the top line for Celgene, versus 6.7% year-over growth for Biogen. Both of these companies are growing their earnings by double-digit percentages, because as their sales increase, they can leverage that against fixed costs, drop more money to the bottom line. Investors are typically willing to pay up a little bit, to get faster growth, and with guidance out of Celgene calling for ... You talked a little bit about 2020. This year, they're still talking about very substantial growth. Next year, they're talking about even more growth, and by 2020, they're talking about a doubling in sales. So not many biotech companies give you that kind of insight into the future prospects. And that's probably why their investors are bidding it up a little bit more than they would be Biogen.
Harjes: Yeah. I just feel a whole lot more confident with Celgene, looking at their future in the next five years or so. They've laid it out, it's very clear, you don't have a whole lot of guesswork to do. With Biogen, as we've mentioned on the show a few times now, they're relying on some of these moonshots at this point. And they do have very successful drugs on the market, and so some of their value proposition is quite clear, but there are also quite a few pretty large question marks surrounding this company. I mean, we talked about, on the May 11th show, Anti-LINGO, and then when we updated you last in June, that drug missed. It missed the mark in trials, the stock tanked. And to me, that indicates that the market is pricing in these moonshots to Biogen's evaluation to some extent, which makes me a little bit nervous about going forward.
They have a couple more really, really intriguing drugs that could be huge that they're working on, but I'd be worried about the potential hit to the company if they don't work out.
Campbell: Right, and that's shifting now to the pipeline issue, and you start thinking to yourself: "Okay, well how de-risked are these pipelines?" The biggest needle mover for Biogen would be an Alzheimer's disease drug, but 99% of those drugs, of Alzheimer's drugs in clinical trials have failed, so how de-risked is that? Not very much so, in my opinion, but if you switch over and you look at Celgene, and you say: "Okay, well they've got a phase 3 drug that theoretically could start competing in multiple sclerosis against Biogen, that has data expected next year; they've got a Crohn's disease drug with data expected next year; and they've got the potential through a partnership they have with Juno Therapeutics to have another blood-cancer drug on the market next year, too." So to me, that seems like the pipeline is a little bit more de-risked than it is with Biogen.
Harjes: Which is interesting, since that is the more expensive company, too. Makes sense.
Campbell: Yeah. The final P obviously is profitability. Both of these companies have, I'll call them, rock-solid balance sheets. I'm not worried about either one of them. They have plenty of cash, billions of dollars on cash on the books, they generate out massive cash flow. I think that you really have to decide: Where do you think these companies will be in three years? Does Celgene have a better chance of orchestrating its game plan, or does Biogen have a better chance of orchestrating its? In my view, I like both. I can make an argument for owning both of these companies, but if I was going to pick one or the other, it would be Celgene.
Harjes: I totally agree with you there, yep. Celgene and Biogen, two huge names in biotech. The next thing we want to talk about is a third of the big names, and it's Gilead Sciences. You hear us talk about this all the time, but we have some new news to share regarding Gilead Sciences. On Tuesday of this week -- but last week by the time you're listening to this -- Gilead received approval of a really interesting new hepatitis C drug.
Campbell: This was not unexpected. I mean, everybody pretty much had said: "The FDA is going to approve this drug."
Harjes: The stock was still up 4%, surprisingly.
Campbell: Which is funny, right? I mean, I guess everybody knew the decision was coming on June 28th, everybody expected the FDA to say: "Yep, we'll approve it." Essentially, what we're talking about here, listeners, is a drug ... How do we want to refer to this one, Kristine? Is it --
Campbell: I haven't looked it up to see how to ...
Harjes: I wish that there were a simple website that pronounced drug names for you. I'm going to go with Epclusa.
Campbell: Okay, so let's maybe get on it, but let's call it Epclusa.
Harjes: Yeah, if anyone knows a resource where I can just watch a video of somebody saying all these drug names, please, send it my way, IndustryFocus@fool.com.
Campbell: We'll go with Epclusa for now. What we're talking about is the first pan-genotype hepatitis C therapy that's been approved by the FDA.
Harjes: What is genotype? Why is that important?
Campbell: Okay. There are several different types of hepatitis C. Each one is treated a little bit differently. Some are easier to treat, some are more difficult to treat. The six genotypes, the most common is genotype 1. That's where these companies -- AbbVie, Gilead, Bristol-Myers [Squibb], and now Merck -- compete most heavily for market share: in treating the genotype 1 basket. That represents about 70% of the two million or so people in the United States that have hepatitis C. Epclusa is the first drug of this new class of drugs that have hit the market in the last three years that is approved to be used in any genotype, 1 through 6. That's pretty intriguing, because it could have some very big impacts on how market share shapes up for the various participants over the course of next year.
Harjes: Absolutely, and the company does seem to be positioning this drug specifically in genotypes 2 and 3, which while not as common as genotype 1, are still pretty prevalent. Genotype 2 is about 15% to 20% of hepatitis C patients, and genotype 3 is about 10% to 12%, so if it can dominate those markets, that's pretty big.
Campbell: One of the biggest questions that was facing management leading up to the approval of this drug was simply: "Well, how are you going to position this drug in the marketplace so it doesn't steal all of the $19 billion in revenue that you're already generated via Sovaldi and Harvoni? How are you going to launch this drug, and not just all the market share that was going to Sovaldi and Harvoni ends up in this drug, and you get nowhere?"
Harjes: Yeah, cannibalization is not helpful at all, especially when the price points are very similar.
Campbell: Right, and you've got a situation where you're plateauing, too, in sales: last quarter, first quarter. Sales actually dipped a little bit for Gilead Sciences in the indication, because competition has gotten a little bit more fierce and pricing has gotten a little bit more competitive. The big question was: "How are you going to position this not to cannibalize?" The way that they've decided to do that is to focus on genotype 2 and genotype 3, which are historically, two of the more difficult genotypes to treat. Right now, you usually have to treat with Sovaldi plus something like ribavirin, or plus Bristol-Myers' Daklinza. These are not as easily cured, say, as genotype 1. Harvoni isn't approved for use in these, so if you position Epclusa to genotype 2 and 3 -- well, then, you've got an opportunity to not cannibalize your own drug, but instead, to cannibalize Bristol-Myers'.
Harjes: An important point to add there, when you're looking at these cocktails of different drugs, are that each have their own prices. So you have to add together the price of drug A, B, and C, if you're taking three drugs to treat your disease. So then, if you look over at Epclusa, which doesn't need, say, a ribavirin, that could actually make it the cheaper option -- even though the list price, when you first look at it, which is $74,500 for a 12-week treatment, it actually could be the cheaper option. And pricing is huge in the hepatitis C market. That is what these companies are competing on, because the drugs are all very effective.
Campbell: Right, and you have to remember, too, the more drugs that you include in a combination therapy, the more risks there are of side effects that may result in a patient discontinuing treatment prior to completing the course, so you could have adherence problems, and as a result, these combination therapies become less efficacious than, say, one pill taken a day every day for 12 weeks.
Harjes: Absolutely. That is --
Campbell: That increases the cost, if you have to go back and you have to treat these patients again, right? I think that Gilead's looking at it and saying: "Okay, Bristol-Myers is bringing in about $1.6 billion from its hepatitis C drugs. A lot of that is probably coming from them being prescribed alongside Sovaldi in genotype 2 and 3 patients; maybe we can capture $1 billion of additional sales by targeting that indication."
Harjes: This is another win for a company that has been very, very successful. You mentioned that we've seen a little bit of a slowdown in hepatitis C, and because of that, this stock is so cheap. I mean, really: the market, I think, is tremendously underappreciating Gilead Sciences. I mean, the headline story right now is: "Oh, no, Harvoni sales have fallen 50% year over year in the U.S." I just am not that concerned about it. I mean, you've got Epclusa coming in now, but even more importantly, there is so much more to this company than just hepatitis C.
Campbell: Oh, yeah! I mean, they've got drugs in belt now for NASH [nonalcoholic steatohepatitis] that theoretically could be billion-dollar blockbusters if they pan out. They've also got a very intriguing deal with Galapagos on a late-stage drug that could target autoimmune diseases, which would be potentially huge. I mean, remember that autoimmune diseases -- that market supports Humira, which is a $14 billion/year drug. Yeah, they have revenue drivers that I think are not being appropriately modeled in by investors right now. I think investors are focusing too much on the flatlining of sales for hepatitis C. In my view, the launch of this drug actually not only solidifies the market share, but could offer upside to the second half of this year that's not baked into a lot of people's models.
Harjes: If you're curious about the ratio, they're trading at under 7 times trailing earnings. That is insane!
Campbell: Yeah. I mean that makes them, by far, the cheapest buy of big-cap biotechs. I think that if you're going to rank the three stocks that we talked about today: Gilead Sciences, then Celgene, then Biogen.
Harjes: I completely agree, and I'll just add, one more part to the Gilead story is that they're sitting on $21 billion in cash on the balance sheet, and they are historically really, really smart about acquisitions. They're taking their time, they're being very patient with it; they're using a lot of the money to buy back their own shares, because hey, they're really cheap. But I would anticipate some interesting acquisitions going forward that could be total game-changers in any of the different disease areas that we've listed, or a completely new one. Who knows? This is a company that I am really excited about, if you can't hear it in my voice. I think, Todd, you are too.
Campbell: Yeah. I mean, I always like good management teams, right? Proven management teams. They've been there, they've done that, and they've proven that they know how to protect portfolios and develop new drugs. Gilead has definitely done that, Celgene has definitely done that.
Folks listening, if you liked the show, leave us a review on iTunes, or however you listen to your podcasts. We really appreciate the feedback, and it also helps us get a broader reach, get some more listeners, get some more people investing Foolishly. As always, the people on the program may have interest in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy yourselves stocks based solely on what you hear. For Todd Campbell, I'm Kristine Harjes. Thanks for listening, and Fool on!