Development-stage drug companies present high-risk, high-reward investments. Clinical trials can fail, deep-pocketed partners can pull the plug, and there never seems to be enough cash on the balance sheet. It's a chaotic period, but companies that make it to the other side of clinical trials and launch a drug product onto the market can finally begin to generate revenue and reward patient shareholders. Then again, commercial drug companies have their own unique set of risks. Take Puma Biotechnology (NASDAQ:PBYI) as one of the latest examples.

After toiling for years to develop its lone drug product, neratinib, an adjunct therapy for breast cancer, it was successful in overcoming regulatory red tape. The drug earned marketing approval in the U.S. in 2017 and received the green light from regulators in Europe. Wall Street scoffed at the slow pace of revenue growth, which sent shares tumbling almost 80% in 2018. So much for leaving behind all that high risk once advancing past the development phase. Considering the business appears to be heading in the right direction, is Puma Biotechnology a buy at a market cap of just $950 million?

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By the numbers

Puma Biotechnology is a one-trick pony that possesses just one asset -- both in the pipeline and on the market. Neratinib, branded as Nerlynx, is currently approved as a stand-alone treatment that can be administered to patients with HER2+ breast cancer after they've completed treatment with the drug Herceptin. It was approved after a phase 3 clinical trial concluded that patients who took Nerlynx for one year were more likely to remain disease-free five years later, compared to those taking a placebo.

Nerlynx is also being evaluated as a standalone or combination treatment in patients with metastatic HER2+ breast cancer and with other HER2-mutated solid tumors. Analysts originally projected blockbuster potential with peak annual sales of at least $1.2 billion, assuming the drug earned marketing approval across all indications. However, those sales figures are in doubt after a slow start in 2018. 

Puma Biotechnology reported $53 million in revenue for Nerlynx during the third quarter of 2018, an increase of only $2 million from the second quarter of last year. Wall Street took that as a sign that the U.S. market launch had stalled out in an unusually short amount of time. It may be too early to reach that conclusion, but investors should be encouraged that the business is quickly heading toward operating profits. 

Metric

Q3 2018

Q3 2017

Year-over-Year Change

Revenue

$62.6 million

$6.1 million

931%

Operating expenses

$73.9 million

$83.5 million

(12%)

Operating income

($11.3 million)

($77.4 million)

N/A

Operating cash flow

($31.1 million)

($136.8 million)

N/A

Data source: SEC filing.

Ramping sales and a sharp decrease in operating expenses led to an 85% reduction in operating loss in the year-over-year period. If Nerlynx can continue to grow revenue -- a likely outcome considering upcoming launches in Canada and the European Union -- then Puma Biotechnology should eventually achieve profitable operations and operating cash flow.

That would be a great outcome for the business, but will it be enough to relieve anxious analysts on Wall Street?

Looking ahead

Wall Street's pessimism might not let up without a blowout quarter or another drastic change. Puma Biotechnology is completely dependent on Nerlynx, which means it won't be able to use profitable operations to fund additional drug discovery or development efforts. If it did, and had another high potential drug candidate or two waiting in the wings, then analysts might be more patient with slow sales growth of Nerlynx.

But management hasn't signaled any intention to jump back into the drug discovery game, so it's a non-starter for now. Considering this, how much of a penalty should be applied to the company's valuation for its one-trick-pony status? Last year's sell-off may have gone too far.

At a market cap of $950 million, Puma Biotechnology shares trade at just 4.7 times sales. That's an absurdly low valuation for a commercial-stage pharma company, especially for one trekking toward profitable operations. Investors might expect a price-to-sales ratio around 2 to 3 times higher -- even in light of the lingering concerns over the pace of growth for the Nerlynx franchise. 

A low valuation might even make Puma Biotechnology an attractive takeover target. Investors have witnessed a flurry of deals in pharma and biopharma space in the last several months. Meanwhile, management's cutthroat approach to reducing operating expenses in the midst of a crucial market launch in 2018 might have been done in part to make the business more attractive to a deep-pocketed suitor.

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Image source: Getty Images.

This pharma stock has a favorable risk profile

Evaluating Puma Biotechnology isn't quite straightforward. On one hand, it owns only one asset that appears to be growing slower than analysts predicted. On the other hand, that one asset has proven to be a successful treatment in multiple clinical trials and looks poised to deliver the business to profitable operations. While upcoming market launches should boost sales growth in 2019, investors will need to ensure the added marketing expenses don't unravel the progress made in reducing overhead last year.

Nonetheless, given the low valuation and the overnight reduction in operating expenses recently, I think investors can comfortably begin a position in Puma Biotechnology at a market cap of around $950 million. Just know that it exited 2018 with a market cap of only $775 million -- so Wall Street clearly has no problems going lower. I think a price-to-sales ratio of 4.7 hints that Wall Street got carried away in doling out punishment last year.

Check out the latest Puma Biotechnology earnings call transcript.