The
Bush Administration is missing the long-term benefit of eliminating the double
taxation of dividends. Increasing the
after-tax return on equities will promote new stock issuance. The balance sheet of U.S. companies will
de-leverage: the equity portion will grow in comparison to debt. This means fewer bankruptcies, enhanced job
security, and attenuation of the economic cycle. And, increased funding for capital spending will create new jobs.
Amgen (AMGN 61), the world’s largest biotechnology company,
has projected that revenues could double by year-end 2005 from 2002’s $5.5
billion. This growth is driven by
miracle drugs that treat several of the most miserable illnesses people can
have. Patent protection is
long-lived. The table below describes
the drugs, and their revenues.
|
Drug
|
Application
|
Disease prevalence in # of people afflicted
|
US patent expiration
|
2002 Revenues
|
2002 – 2005 projected growth rate
|
Potential peak revenues
|
|
Aranesp
|
Chronic renal insufficiency and chemotherapy induced anemia
|
>2 million
|
2018
|
$2.8 billion
|
20%-25%
|
$5 billion
|
|
Enbrel
|
Rheumatoid arthritis and psoriatic arthritis
|
>3 million
|
2012
|
$2.0 billion
|
40%-50%
|
$3 billion
|
|
Epogen
|
Anemia associated with chronic renal failure (kidney disease)
|
>3 million
|
2013
|
$2.3 billion
|
4-7%
|
$3 billion
|
|
NEUPOGEN/ Neulasta
|
Chemotherapy induced neutropenia (susceptibility to infection)
|
>1 million
|
2013
|
$1.6 billion
|
20%-25%
|
$3 billion
|
Amgen’s
$3 billion in operating cash flow is funding increases in drug
development. Amgen now has 40,000
people enrolled in its clinical trials worldwide as compared to about 10,000 in
1998. There are now 32 molecules in
development compared to 16 in 2000.
Amgen’s current products have enormous unexploited therapeutic
potential. For years to come, Amgen will be mining the future potential
applications of Enbrel including psoriasis, ankylosing spondylitis, acne,
gangrenosum, hepatitis C, asthma, and cancer.
Other new product prospects are Cinacalcet HCl for
hyperparathyroidism-induced chronic renal failure, filing expected in the
second half of 2003, and KGF for mucositis induced by chemotherapy, filing
expected in 2004. Early stage molecules
include Epratuzumab for non-Hodgkins lymphoma, EFG-R Antibody for solid tumors,
AMG 548 P38 enzyme inhibitor for inflammation, and Glial-Derived Neurotrophic
Factor for Parkinson’s disease.
Cash
is also being invested in new pharmaceutical manufacturing plants in
geographies with lower tax rates. $1
billion is to be spent on repurchasing stock this year. There are no prospects for a dividend.
The
expensive stock price discounts the exceptional growth in Amgen’s future. On 2002 earnings of $1.39 per share
(adjusted for non-recurring items) the p/e is 44, and on projected $1.70- $1.80
for 2003, 35 times earnings. Amgen
projects 25-27% e.p.s growth through 2005; the math gives a range of $2.71 to
$2.85, for a p/e of about 22 on 2005 earnings.
Intrinsic value computed by discounting the estimated future economic
profits stream is in the high $40’s.
Quidel (QDEL $4.00) is a leading manufacturer of point-of-care
(POC) medical diagnostics for hospitals, clinical laboratories, and doctor’s
offices. The company’s market shares in
Pregnancy, Group A Strep, and Influenza are 55%, 49%, and 41%,
respectively. The company also makes
products for autoimmune diseases, osteoporosis, urinalysis and various
infectious diseases.
There
are plenty of suppliers of medical test kits, making them a commodity, and this
is reflected in the disappointing historical financial results of this
24-year-old company. However, two years
ago new management took over and has taken positive steps towards updating
manufacturing and investing in product marketing and promotion. But it is new product innovation and
development that has peaked my interest in Quidel.
The
company started launching products in July 2002 based on a significant patented
technological innovation in test kit manufacturing called LTF, Layered Thin
Film technology. Using a process
similar to printing, multiple layers of test reagents are applied to a credit
card sized test sheet. This technology
eliminates the steps of mixing multiple reagents that have restricted many
tests to the clinical lab. Tests are
performed by the doctor swabbing the infected area and then rubbing the swab on
the LTF card. Contact of body fluids
with the card rapidly causes color changes that indicate the test results. Diagnosis can be confirmed before the
patient leaves the doctor’s office, allowing care to start immediately. Point of care (POC) testing saves money for
medical care payors. POC test kits cost
less and rapid diagnosis reduces potential complications of delayed or
incorrect care. For these reasons,
healthcare providers are trending towards the POC sector of the diagnostic
testing market that Quidel focuses on.
To the benefit of Quidel shareholders, LTF test kits have higher profit
margins than traditional test kits, due to substantially lower manufacturing
labor expense.
A
new urinalysis instrument called UrinQuick was introduced in November of 2002,
which allows physician office laboratories to analyze entire batches of urine
strips for the presence of 10 important health markers that assist in the
diagnosis of diabetes, liver and kidney disease, urinary tract infections and
other health parameters.
The
main risk of owning Quidel stock is the company’s unremarkable history. To paraphrase Warren Buffett, when a
management with a good reputation takes over a business with a bad reputation,
it is usually the business’ reputation that survives. So, there is danger in believing the new managers have a plan and
discipline that will succeed. Also, the
industry is very competitive, with well-capitalized companies such as Becton
Dickinson, Beckman Coulter, Genzyme, Roche and Bayer to compete with. The company has long-term lease obligations
but no debt. There is no significant
litigation cited in the annual report and 10K, although the industry has a
predisposition towards intellectual property disputes. Approval to sell test kits must be obtained
from the FDA, along with approval of manufacturing facilities.
Management
is very confident of 17% revenue growth for the next three years, accompanied
by a substantial margin increase. So, earnings should grow even
faster. My estimate of intrinsic value
based on these expectations is $7. The
stock has ranged between $2 and $9 over the past several years. There are only 30 million shares
outstanding, so the stock is difficult both to buy and sell. This $4 stock has little following on Wall
Street. Only 3 sell-side analysts follow the company, so the rare
possibility exists of uncovering a situation the whole world does not know
about yet.
Pfizer (PFE 32) has closed the acquisition
of Pharmacia (PHA 45), exchanging 1.4 shares of Pfizer per share
of Pharmacia. To address government
anti-trust concerns Pharmacia has been required to return apomorphine to
Nascent Pharmaceuticals, and Pfizer has agreed to divest darafenacin, Ketensin,
Parkemoxin, and an experimental Viagra replacement called PNU-142774E. These divestments will have a negligible
effect on the combined business of Pfizer and Pharmacia.
The main benefit of the acquisition remains in place: Pfizer is the number one competitor in all
major pharmaceutical product categories.
This further adds to Pfizer’s product diversification and ability to
offer a full range of products to large pharmaceutical buyers.
I estimate that the acquisition will be about 3 cents
dilutive to earnings per share in 2003.
Cost synergies attained by eliminating facility and personnel
duplication will be a significant earnings growth driver in future years,
starting at 4 cents anti-dilutive in 2004 and accumulating 40 cents over
several years. New products Bextra,
Geodon, Repax, Rebif, Spiriva, and Vfend and a full R&D pipeline should
keep Pfizer at the top of its industry.
Product flow and acquisition integration should drive operating earnings
growth to $1.77 in 2003 and over $2.00 in 2004. Free cash flow this year should be about $1.45. With intrinsic value approaching $40, Pfizer
looks cheap at the current price.
The major risks to Pfizer are delays in or failure to
receive FDA approvals of new drugs and the concentrated efforts on the part of
generic manufacturers to break down the patent protection of Pfizer’s
inventions Neurontin and Norvasc.
Patent expirations will limit growth in 2006 to 2008: Zithromax (11/05),
Zoloft (6/06), Norvasc (1/07), Geodon (3/07), Zyrtec (12/07), and Camptosar
(2/08).
Steven L. Ré, CFA
April 22, 2003
The above is for information purposes only and is
not to be construed as a recommendation to purchase or sell securities. The above information is from sources deemed
reliable but is not guaranteed. It
should not be assumed that investments in any of the above-mentioned securities
will be profitable, and past performance is not a guarantee of future
results. Earnings projections often
miss, and markets sometimes go down.
The employees and families of Quality Growth Management, Inc. may own
the above-mentioned securities in their own accounts, and may trade them at any
time without notice.