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Amgen: Compelling Valuation

- By Ben Reynolds

Dividends don't just appear out of thin air. When a company pays a dividend, the payment comes from accumulated profits. The accounting treatment of dividends is as follows: Once the dividend is declared, the capital used to pay the dividend is deducted from the company's profit. In order to pay future dividends or increase the dividend, those profits have to be replaced.


Having a dividend policy is a sign that a company has matured. The business has performed so well that is has more profits than it needs to reinvest in the business. Those companies that are able to pay and raise its dividend over long periods of time are well regarded by investors. These lengthy growth streaks show a company is able to generate consistent profits, even when the economic cycle is unfavorable. Those companies that cut their dividend do so because profits have declined.

Companies aren't required to pay dividends to shareholders of common stock, but those that generate an abundance of cash often choose to do just that. Paying (and growing) a dividend demonstrates to investors that the business is very profitable and that the company expects profits to grow in the future. One such company that only recently initiated its dividend, but has seen immense growth in profits, is Amgen Inc. (AMGN).



Company background

Amgen was created in 1980 and started with a workforce of just three employees. Today, it has a market cap of $134 billion, making it the world's largest independent biotech company. Amgen develops, manufactures and markets treatments for illnesses in areas such as cardiovascular disease, oncology, neuroscience and bone health. The company had nearly $23 billion in sales last year.

Most recent earnings results

Amgen's most recent earnings results were released on July 26. The company earned $3.83 per share during the second quarter. This was 29 cents above the average analysts' estimate and a 17% increase from the prior-year quarter. Revenue increased more than 4% to $6.1 billion, topping estimates by $330 million.

Amgen saw solid sales growth for several of its medicines in the quarter.

  • Sales for Neulasta, which stimulates the growth of white blood cells and is Amgen's second-bestselling drug, grew 1% to $1.1 billion.

  • Sales for Prolia, a treatment for osteoporosis, increased 21% to $610 million.

  • Sales for XGEVA, a treatment for bone problems due to cancer, climbed 14% to $452 million.

  • Sales for Repatha, which helps to control cholesterol, grew 78% to $148 million.



While sales for some of these drugs are still relatively small, the increases are very impressive and are likely to continue for some time. For example, Repatha was only available in the U.S. until recently. The European Commission gave approval for Repatha in May. This will likely lead to higher sales growth going forward.

On the other hand, some of Amgen's top-selling medicines saw sharp declines in the quarter.

  • Enbrel, which treats rheumatoid arthritis, saw sales decline 11% to $1.3 billion.

  • Aranesp, a treatment for anemia, experienced a sales drop of 12% to $472 million.



Even after a double-digit drop in sales, Enbrel is Amgen's top-grossing drug. A decrease in demand for Enbrel has led to lower selling prices. Markets often react negatively to drug companies who see their top-selling drug post revenue declines of this magnitude. In Amgen's case, this may not be a major issue. The company has an agreement in place with AbbVie (ABBV) to begin producing a biosimilar for Humira. Amgen will be able to market it biosimilar for Humira, the top-selling drug in the world, in the European Union starting next month. Amgen will be able to sell its biosimilar in the U.S. starting in 2023.

Amgen updated its guidance for 2018 on the conference call. The company expects earnings per share to fall in a range of $13.30 to $14, up from a range of $12.80 to $13.70 previously. At the midpoint ($13.65), this would be an 8.5% improvement from 2017's earnings per share. The company now guides toward a midpoint for revenue of $22.85 billion, up from $22.35 billion earlier. This would be slightly above last year's sales total.

Amgen will report third-quarter earnings on Oct. 24.

Dividend history and valuation

Amgen wasn't always a dividend payer. Before 2011, the company used profits to reinvest in the company and to buy back shares of its own stock. Eventually, the growth in profits allowed Amgen to begin paying a dividend.

In the dividend growth universe, Amgen is a relative newcomer as the company has only paid a dividend since 2011. The company has increased its dividend every year since then, often aggressively. Amgen has increased its dividend:

  • By an average of 23.5% over the past three years.

  • By an average of 26.1% over the past five years.



Amgen's is expected to pay out $5.28 in dividends in 2018, an increase of nearly 15% from 2017. In addition, the company has a very low payout ratio. Over the past eight years, the average payout ratio was just 26.7%. Based off of expected dividends and the midpoint for earnings per share for 2018, Amgen has an expected payout ratio of 38.9% for this year. Though this would be the highest payout ratio since the dividend was initiated, there is still plenty of room for the company to increase its dividend even if earnings per share were to decline. The stock currently yields 2.55%.

While over 20% dividend growth may be coming to an end, double-digit dividend increases are still likely to happen given projected earnings per share growth. Helping matters is Amgen's seemingly endless hunger to retire its own shares. From 2008 through 2017, the company repurchased more than 30% of its share count. This helped earnings increase more than 12% per year during this period. Without the buyback, earnings per share growth was 8.3%. Between dividends and buybacks, Amgen has proven to be a very shareholder-friendly company.

Based off Monday's closing price of $206.91 and the midpoint for earnings per share guidance ($13.65), Amgen's stock trades with a price-earnings multiple of 15.2. The average price-earnings ratio over the last decade is 12.9. While the valuation is high relative to its own history, Amgen's price-earnings ratio is very low compared to that of the S&P 500 (25.3). The company's yield is well above that of the S&P 500 (1.74%) and offers a much more compelling valuation. Even as shares are up 19% year to date and more than 41% since the beginning of 2017, Amgen's pipeline of drugs offers the potential for further stock price appreciation and further dividend growth.

Conclusion

Before a company can pay its shareholders a dividend, it must demonstrate that it is profitable. Once a company finds itself flush with cash, initiating a dividend is a great way to return capital to shareholders. Those companies that can grow their dividends for a long period of time show investors they can perform well even in adverse market conditions.

Amgen has seen earnings grow by more than 12% for the last decade and expects to increase earnings per share by a healthy rate this year as well. While certain products have seen sales decline, Amgen's newer offerings have shown impressive growth rates. Add in an agreement to market a biosimilar for Humira and the company is poised for further growth in the future. While the dividend growth streak is just eight years, Amgen's ability to increase profits and maintain a low payout ratio likely means the company will continue to increase its dividend in future years.

Disclosure: Author is long ABBV.

This article first appeared on GuruFocus.


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