Investors looking for an undervalued biotechnology stock that provides long-term profitability should consider adding Exelixis (EXEL 0.71%) to their portfolios. Exelixis is a profitable company thanks to the success of its lead cancer drug, Cabometyx, which treats various forms of cancer, including kidney, thyroid, and liver. 

Cabometyx, a brand name of the compound cabozantinib, is a targeted therapy that focuses on inhibiting an enzyme called tyrosine kinase that plays a role in cell functions, including cell signaling, growth, and division. In cancer cells, these enzymes are often too active or found in high levels, so treatment requires the use of tyrosine kinase inhibitors. Since 2001, the FDA has approved more than 20 tyrosine kinase inhibitors to treat different forms of cancer. How does cabozantinib differ?

Two doctors look at brain scans

Image source: Getty Images.

Moat in oncology

Exelixis' Cabometyx drug franchise is currently the only tyrosine kinase inhibitor in the oncology space that provides overall survival benefit for patients with advanced forms of kidney and liver cancer such as renal cell carcinoma (RCC) and advanced hepatocellular carcinoma (HCC). This franchise generates more than $1 billion in global net revenue on an annual basis, and management expects this trend to continue into 2020. 

At the recent 38th annual J.P. Morgan Healthcare Conference in San Francisco, Exelixis' CEO Michael Morrissey laid out the company's plans for 2020. He noted that this year will be full of investment, and he anticipates top-line results in 2020 from six potential label-enabling studies that will allow cabozantinib to be approved for use on additional types of cancers. If these studies are successful, the FDA may consider approving four new indications of cabozantinib in the fiscal year 2021. 

Moreover, management expects to build out the pipeline with up to three new Investigational New Drug (IND) filings in 2020 for new clinical trials in the future -- potentially good news for investors, as this could improve the number of patients who can benefit from the cabozantinib compound. Management expects to eventually address a patient population four times larger than the current one living with advanced RCC and HCC. The overall result would significantly affect the business, moving U.S. net product revenue to $4 billion by 2025. 

Investors should be pleased with management's guidance for Exelixis in 2020, indicated in the table below: 


2020 Guidance (Provided Jan. 12)

Total revenue

$850 million to $900 million

Net product revenue

$725 million to $775 million

Cost of goods sold

4% to 5% of net product revenue

Research and development (R&D) expenses

$460 million to $500 million

(includes $25 million in non-cash stock-based compensation) 

Sales, general, and administrative expenses

$230 million to $250 million 

(includes $30 million in non-cash stock-based compensation) 

Effective tax rate

20% to 22%

Cash (at year-end 2020)

$1.5 billion to $1.6 billion

Data Source: Exelixis.

Powering forward in 2020

The company has demonstrated profitability in the past 12 quarters, generating $1.4 billion in cash and investments in 2019. Preliminary fourth-quarter and full-year 2019 results showed $245 million and $972 million in total revenue, respectively. 

Total revenue will remain modest compared to 2019, based on management's conservative estimates of the current RCC and HCC market. Morrissey noted that increased investment in R&D will allow the company to do meaningful work across a variety of different trials to bring forward potential INDs. The free cash flow increase of $100 million to $200 million will allow the company to stay flexible and encourage business growth. Overall, all this is good for investors, who can expect results this year similar to 2019, with a focus on promising drug candidates and continued profitability. 

One especially compelling metric for investors is Exelixis' return on equity (ROE), which at 48.6% implies that the company is using its assets effectively to create profits. A higher ROE is better -- it means more profit with less capital -- so when comparing Exelixis with peers such as Bristol Myers Squibb, which has an ROE of 36.1%, it's clear Exelixis' management is doing a better job creating profits and effectively managing investments.

Valuation is attractive

The company's forward P/E ratio, a measure of share price relative to per-share earnings, is 26, and its PEG ratio, which measures price and earnings relative to growth, is 0.45. Investors should focus on the PEG ratio because the P/E ratio does not account for future earnings growth, and using the PEG ratio provides a more accurate valuation measure. A PEG ratio of 1 represents the perfect correlation between P/E ratio and projected earnings growth while a ratio of less than 1 indicates that the stock is undervalued. Since Exelixis' PEG ratio is 0.45, investors can see the stock is currently undervalued and is headed for future growth.

Looking at the company's financials and the long-term implications of its drug pipeline, investors will find an undervalued pharma stock with a promising future. Investors can expect to excel with Exelixis in 2020 and beyond.