Beat and Raise: Big Biotechs' Outstanding Quarter

For most biotechs, earnings season is nothing more than a chance to update investors on their pipeline and how much cash they still have. Revenue, if they have any, is often payments from partners amortized over the life of the deal, which makes the net loss kind of useless.

But with multiple drugs to sell, earnings season actually matters for the four big biotechs: Amgen (AMGN -1.33%), Gilead Sciences (GILD -2.70%), Biogen Idec (BIIB 0.23%), and Celgene (CELG). For the most part, they got it done in the third quarter. All four companies beat analysts' expectations and raised their guidance for the year.

Source: Company releases.

Growing the bottom line
Amgen, Biogen, and Celgene all grew profits substantially faster than they grew revenue. Like their big pharma brethren, the large biotechs are increasing cash flow and earnings by cutting costs. Getting more efficient is certainly the right thing to do, but don't expect it to go on forever; there's only so much fat that can be cut.

EPS can also increase faster than revenue if a company has fewer shares outstanding after repurchasing shares over the last year. Amgen especially has been a prolific share repurchaser; there were nearly 14% fewer outstanding shares in the third quarter compared to the same period in 2011.

The glaring exception
That 2% decrease in Gilead's earnings sure does stick out like a sore thumb. But investors shouldn't be all that upset. Gross margins actually increased year over year. And the company kept sales and marketing costs in check even as it launched its quad HIV pill, Stribild.

The main culprit was research and development costs, which ballooned up a whopping 60% year over year. The old adage that you have to spend a buck to make a buck counts double in biotech.

Gilead is pushing its hepatitis C drug cocktail forward, which is undoubtedly a big chunk of the increase in R&D spending. The biotech is in a race with Abbott Labs (ABT -0.03%), Bristol-Myers Squibb (BMY -8.51%), and others to bring the next generation of hepatitis C drugs to market; at this point, speed is more important than costs.

Best bet
Of the four, Biogen looks the strongest. Beyond the operational efficiencies, it has a solid pipeline to grow revenue further. Its oral multiple sclerosis drug BG-12 should be headed for approval in December, and the company is looking to enter the hemophilia market with a pair of drugs that passed their phase 3 trials and offer convenience over the current therapies.

And Biogen's current offerings still have life in them even if the 6% growth in the most recent quarter didn't really show it (currency changes and some delayed payments hampered revenue). Biogen and its partner Elan (ELN) have developed a test to identify which patients are more susceptible to Tysabri's side effects, which should make doctors more comfortable with prescribing the drug for those that don't test positive.

You'll have to pay up for that extra strength. From a valuation prospective, Biogen is more expensive than the others. But as Warren Buffett said, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."