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Amgen (AMGN)

Amgen (AMGN) was founded in 1980 and is one of the world's leading biotechnology companies with operations in more than 100 countries. The business develops and manufacturers treatments for oncology/hematology, cardiovascular, inflammation, bone health, nephrology, and neurological diseases. 

Amgen's product portfolio is concentrated in a handful of drugs. In the fourth quarter of 2017, the company's most important drugs included:

  • Enbrel (treats rheumatoid arthritis): 26% of sales sales (declined -13%)
  • Neulasta (bone marrow stimulant used in cancer patients) 20% of sales (0% growth)
  • Prolia (treats osteoporosis in postmenopausal women) : 10% of sales (grew 24%)
  • Aranesp (bone marrow stimulant used during chemotherapy or kidney failure): 9% of sales (declined -7%)
  • Sensipar/Mimpara (calcium reducer used to treat kidney disease): 7% of sales (0% growth)

The company's largest potential blockbusters include (for perspective, Amgen's total sales in 2017 were approximately $23 billion): 

  • Prolia (bone disease) - expected peak annual sales of $2 billion
  • Xgeva (cancer patient fracture prevention) - expected peak annual sales of $2 billion
  • Kyprolis (cancer drug, multiple myeloma) - expected peak annual sales of $2 billion
  • Repatha (cholesterol lowering antibody) - expected peak annual sales of $4 billion

Amgen's revenue declined 1% in 2017, but thanks to strong cost cutting and share buybacks, the company's adjusted EPS grew 8%. Management is expecting similar results in 2018. 

Business Analysis

Amgen was one of the earliest biotech companies and specilized in biologically-derived medications. These can be more effective and have better safety profiles compared to chemical-based pharmaceuticals. 

The company has historically been strongest in cancer drugs and those treating renal (kidney) conditions. Over time Amgen has diversified its product lines and now targets 13 different conditions, including more common (and thus larger market) conditions such as high cholesterol, migraines, and arthritis. In fact, osteoporosis drug Prolia has experienced over 30% sales growth since 2012 and was the world's most popular biological medication for that condition last year. 

Despite a relatively aging product portfolio, Amgen has been able to leverage its large scale and low-cost manufacturing to great effect, creating very strong operating margins and free cash flow margins north of 40% last year. This has helped the company build up a cash position in excess of $40 billion at the end of 2017. 

Amgen recently announced it was repatriating $39 billion in offshore cash under the new tax law, meaning that $33 billion of this will soon be domestically available. The company plans to spend this on buybacks, dividends, acquisitions, R&D, and further investment into improving the efficiency of its low-cost manufacturing capabilities (in order to maintain greater than 50% operating margins). 

Like all biotechs, Amgen has to spend a lot on R&D in order to continually develop new drugs to replace ones whose patents are expiring, or who face sales pressure from biosimilar drugs created by competitors (these drugs treat the same condition, but via slightly different biochemical pathways). In 2017 Amgen spent nearly $3.6 billion on R&D, or about 16% of sales. 

However, one major advantage Amgen enjoys is the relatively diversified nature of its sales. For example, many biotechs end up highly concentrated in just one or two key blockbuster drugs which can result in up to 50% or 60% of earnings and cash flow coming from a single product. This can lead to enormous volatility in the top and bottom lines when increased competition arrives and forces a company to reduce its price in an effort to maintain market share. 

While Amgen derived 27% of its sales from its top drug (Enbrel) in 2017, the company's concentration is expected to decline over the coming decade. For example, by 2026 Repatha is expected to be the company's biggest seller, with $4 billion in sales, but account for just 19% of total revenue. Increased diversification should help to smooth out cash flows over time and provide enhanced dividend safety and long-term growth potential. 

Better diversification is likely to come from Amgen's development pipeline of 33 drugs. The pipeline also contains versions of biological drugs (called biosimilars), including Amgen's own versions of blockbuster such as: 

  • Cancer drug Avastin: chemotherapy drug with $7 billion in global sales in 2015
  • Cancer drug Erbitux: $1.3 billion in global sales
  • Arthritis drug Remicade: $5.8 billion in global sales
  • Cancer drug Rituxan: $7.3 billion in global sales
  • Atypical hemolytic uremic syndrome drug Soliris : $5.6 billion in projected 2020 sales
  • Breast cancer drug Herceptin: $6.8 billion in global sales

While Amgen isn't going to be able to take all of these global sales away from their established blockbusters, analysts expect that within the next decade Amgen's biosimilar pipeline should be able to generate about $2.6 billion in annual sales by 2026. That would represent about 12% sales growth off 2018's revenue guidance levels. 

Overall, Amgen plans to increasingly target markets that benefit from the long-term aging of the global population (cancer, inflammation, heart disease, and osteoporosis). Combined with its corporate culture of returning large amounts of free cash flow in the form of large buybacks and fast-growing dividends, Amgen could be a potentially interesting long-term income growth investment. 

However, like all biotechs and pharmaceutical firms, Amgen has numerous complex risks it will have to deal with in the future. 

Key Risks

Amgen's sales have been struggling to grow in recent years for several reasons, including an aging portfolio of products. For example, the last blockbuster the company launched was Prolia in 2012. That was under former CEO Kevin Sharer, who led the company's golden age of peak growth and soaring profitability (from 2000 to 2012).

The current CEO, Robert Bradway, joined the company in 2006 and previously spent nearly two decades as an investment banker at Morgan Stanley. While much of his investment banking experience was specialized in the drug sector, he has limited medical experience in the actual science that ultimately drive Amgen's product development.

Bradway's background should help as the drug industry continues consolidating, driving by increased regulatory scrutiny and a more challenging environment to put through price increases.

In the meantime, Amgen has been aggressive driving cost savings from its supply chain and production facilities. However, there is only so much cost cutting that can be done before it starts to risk affecting quality of R&D, product safety, or inadequate investment into the future.

Amgen will ultimately need to execute on its R&D pipeline, including its biosimilar efforts. That's especially true since numerous rivals have been pouring billions of dollars into developing biosimilar versions of some of Amgen's most important products, including Neulasta (20% of sales) and Enbrel (26%).
Source: Financial Times

While Amgen has its own biosimilars in development, as you can see it's a very crowded field. For example, arthritis drug Remicade, for which Amgen is working on a biosimilar version, will have to deal with at least 20 other products that are being developed by rivals. 

As a result, the amount of market share Amgen might steal from well-established blockbusters might be smaller than anticipated and result in far slower sales and earnings boosts than hoped for. 

In fact, even with its large pipeline of biosimilars, analysts estimate that Amgen will only generate low-single digit annual sales growth over the long term. Earnings are expected to grow somewhat faster thanks to continued share buybacks.

While that modest amount of bottom line growth is better than nothing, especially in the pharma industry, it's not likely to continue to allow the kind of strong double-digit dividend growth that Amgen investors have enjoyed in recent years. 

The company faces numerous other challenges as well, including potential regulatory and reimbursement changes from Medicare that can negatively affect some of its drugs. Medicare and Medicaid (which cover about 50% of the U.S. population) don't currently have the ability to negotiate for lower drug prices for bulk purchases. However, with the state of Federal healthcare policy constantly in flux, this could change. 

Additionally, Amgen's strong margins are something that politicians and private companies alike want to reduce. Recently Jeff Bezos (CEO of Amazon), Warren Buffett (CEO of Berkshire Hathaway), and Jamie Dimon (CEO of JPMorgan Chase) announced they are teaming up to create a new company that's designed to provide lower-cost healthcare to their companies' employees (about 1 million people). 

This company is supposed to focus on achieving maximum technological and big data innovation (which Bezos has mastered at Amazon) and strong economies of scale to help it to negotiate lower drug prices, including for many of Amgen's products. It's also said that the company won't care about generating a profit, which seems to fit well with Bezos's modus operandi as well. 

Basically, the drug industry, while blessed with the ability to generate substantial profits (patent protection on wildly profitable drugs), is also a byzantine world of uncertainty and unpredictable challenges in actually bringing drugs to market (drug trial failures) or maintaining market share once they get there. 

As a result, the drug industry tends to be characterized by highly volatile earnings and is generally not a great place for conservative income investors to consider. 

Closing Thoughts on Amgen

The biotech industry is one that many investors put firmly in the "too hard" box, which is understandable. Even for industry leaders with long track records of solid growth and innovation, such as Amgen, there are numerous risks that are hard to quantify (patent losses, regulatory changes, biosimilar competition, etc.). Amgen's drug concentration is hard to get comfortable with as well.

With that said, Amgen appears to be one of the best and most profitable biotechs in the industry. The company's strong cash flow, substantial cash position, and large development pipeline should continue to allow it to reward income growth investors with secure and, at least for now, fast-growing payouts. 

However, it's worth repeating that these types of companies are just too complex and risky for most conservative income investors. Investors who have a higher risk tolerance and are willing to deal with the volatile nature of the biotech sector should also be sure to size their positions accordingly and only buy at valuations that provide compensation for the high risks associated with the industry's challenging business model. 

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