Just last week, I wrote why you'd be smart to buy Vertex Pharmaceuticals (VRTX 2.35%) stock. At that time, Vertex was up around 70% for the year. My argument then was that the stock was still undervalued even with a forward earnings multiple of 41 because of its growth prospects, particularly with its three-drug combination treatments for cystic fibrosis (CF).
Vertex announced results from phase 1 and phase 2 studies of three different triple-combination CF therapies on Tuesday. To call those results positive would be an understatement. The biotech's share price soared more than 20% on the news of just how successful the triple-combo regimens were.
With Vertex stock at all-time highs, is it too late to buy shares of this hot biotech? Here's why I still think the answer to that question is a resounding "no."
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What those results mean for Vertex
Vertex's phase 2 study results were what really excited investors. The company reported that a triple-combo featuring experimental drug VX-152 with tezecaftor and Kalydeco improved a key measure of lung function in CF patients by 9.7%. Another triple-combo with VX-440 produced an increase in the lung function measure of 12%.
How good is this for Vertex? Anything above a 2.5% improvement would have been viewed positively. The performance of the biotech's three-drug combos bodes well for Vertex's chances in ultimately winning approval for the regimens. Vertex plans to begin late-stage studies of one or more of these therapies in the first half of next year that should be the final key prerequisite for filing for regulatory approval.
To put all of this into perspective, it's important to understand that Vertex's currently approved drugs, Kalydeco and Orkambi, only treat CF mutations for around 30,000 patients. Additional label expansions for these drugs plus potential approval for a combination of tezecaftor and Kalydeco could expand the company's market to around 44,000 patients.
But here's why the stellar phase 1 and phase 2 results for the triple-combos are so critical: If approved, they would increase Vertex's potential market to 68,000 patients. That's 90% of all CF patients.
Is Vertex overpriced now?
So these latest results were great news for Vertex, but what about the stock's sky-high valuation? Thanks to this week's big surge, Vertex's shares now trade at a whopping 50 times expected earnings. Some might think that the stock has moved higher than its growth prospects warrant. I disagree.
Let's do some backwards calculations. Vertex now claims a market cap of roughly $40 billion. A price-to-sales ratio of 13 isn't unrealistic for a rapidly growing company. That's right in line, for example, with Biomarin, another biotech focusing on rare diseases. Dividing $40 billion by the price-to-sales ratio of 13 gives an annual sales figure of just over $3 billion.
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What would it take for Vertex to achieve annual sales of $3 billion? If we assume that the company is successful in gaining approval for the tezecaftor/Kalydeco combo and its promising triple-combos, there's a potential market size of 68,000 patients. If Vertex captured all of that market, it would need to price its drugs at around $44,000 annually to hit the target sales mark.
Of course, Vertex probably wouldn't be able to get all of those patients. Let's say the biotech only captured 50% of the potential market. That would mean Vertex would need to price its drugs at around $88,000 per year to justify its current market cap.
Consider that Kalydeco hit the market with a list price of $300,000. Orkambi's list price is $259,000. Vertex could price its potentially forthcoming two- and three-drug combos lower than its current drugs, capture less of the market than we were assuming, and still be worth more than the current share price.
Still some risks
Vertex still faces risks, though. There's always the possibility that future clinical trials don't go well. Regulatory agencies could throw a wrench into the biotech's plans.
And Vertex isn't the only company working on CF treatments. Galapagos NV (GLPG 0.56%) and AbbVie (ABBV 2.10%) are working together to develop new CF drugs. The two drugmakers successfully completed phase 1 studies with three different potential combo components. Galapagos announced in June that it plans to initiate its first clinical study of a triple-combo in the fourth quarter this year. It could be that Galapagos and AbbVie develop a more effective, safer treatment than Vertex's candidates.
Still, Vertex has at least a year's head start over these rivals. The biotech is clearly in the driver's seat right now -- and probably will be for a long time to come. Despite some remaining risks, I continue to believe that Vertex has a compelling growth story. It's not too late to profit from this hot biotech stock.
