As the stock market recovered in 2009 through 2011, almost every sector posted impressive gains. Those steady-as-she goes increases continued for most stocks well into 2012 and 2013, but major biotech stocks simply took off like a rocket. Many of them surged more than 100% over the past two years, creating tens of billions of dollars in profits for investors.
Leading biotechs refilled their drug pipelines (through both acquisitions and internal R&D), which set the stage for steady and solid sales growth. Thirty-nine new drugs were approved by the FDA in 2012, a rate not seen since the mid-1990s. That flurry of approvals helped fuel sales growth in subsequent years, even though the number of new approvals dropped to 26 in 2013, according to Goldman Sachs.
Though most biotech firms have seen their growth prospects ebb and flow from year to year, few have been as steady as Celgene (Nasdaq: CELG), which continues to crank out new drugs treating various types of blood cancers (known as myelomas) and pancreatic cancer. Investors have responded, boosting its shares from $60 in the summer of 2012 to a recent $165.
Expressed another way, shares traded for around 10 times forward EPS of around $6 back in mid-2012 and now trade for roughly 18 times consensus projected 2015 EPS of around $9. In hindsight, the former forward multiple of 10 was never warranted -- and the current forward multiple certainly isn't, either.
One of the key reasons this stock began its 2012 surge was an expectation that a major drug company such as Merck (NYSE: MRK) or Pfizer (NYSE: PFE) might look to acquire Celgene, paying a nice premium to its $25 billion market value. Now that Celgene is worth nearly $70 billion, there's simply no way a big drug firm can afford to buy the company.
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Another reason why Celgene and its peers have been rallying: "Between the end of 2011 and through YE13 large-cap biotech companies launched seven new drugs... In general these launches have delivered and initial sales have exceeded expectations leading to significant upward revisions in consensus estimates," according to analysts at Goldman Sachs. They add that six more major drug launches are planned for 2014, highlighting why this sector continues to trade near all-time highs. Celgene will have one of those drugs if apremilast, its psoriatic arthritis drug, gets FDA approval as expected late in the first quarter.
Even as the biotech industry continues its new drug launch momentum in 2014, Celgene in particular faces some potential catalysts that may finally break this stock's bullish momentum.
For starters, management appears to have unrealistically high hopes for the imminent launch of apremilast. The company expects the drug to be a blockbuster, racking up $1.5 billion to $2 billion in sales by 2016. Goldman Sachs, which has a "sell" rating on the stock, thinks that figure will be closer to $750 million, mostly because Johnson & Johnson's (NYSE: JNJ) Stelara drug is simply more effective in treating psoriatic arthritis.
Merrill Lynch, which rates CELG a buy, shares that concern about this new drug: "We recently cut our sales estimates for CELG's impending launch for apremilast to (about one-third) of CELG's 2017 projections, reflecting our cautious view on the product profile."
The key difference between Goldman's bearish outlook and Merrill's bullish outlook: Goldman thinks investors will negatively respond to a weak launch, while Merrill's analysts think investors will look beyond that negative catalyst.
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Perhaps of even greater concern is the threat to Celgene's cancer drug Revlimid, which accounts for roughly two-thirds of the company's sales. In late October, Bristol-Myers Squibb (NYSE: BMY) announced very positive clinical data for its cancer drug nivolumab, and the FDA has granted a fast-track designation for the drug as a treatment for lung cancer, renal cell carcinoma and advanced melanoma.
Celgene's Revlimid currently stands as the leading treatment for advanced melanoma. Bristol-Myers Squibb is expected to release further clinical data for nivolumab as the year progresses.
"If the data demonstrates the ability to induce durable complete responses, this could shift the paradigm" in multiple myelomas, note Goldman's analysts, who expect that data could well lead Bristol-Myers Squibb to pursue all cancers, including myelomas. This would amount to an existential threat to Celgene. Cementing their point, Goldman’s analysts note that "CELG is the most exposed company in our coverage universe."
To be sure, it's too soon to know if apremilast will face a disappointing launch, or if Revlimid's myeloma franchise faces a real threat from nivolumab, but these two events stand out as the biggest potential negative catalysts for this high-flying stock. Further clinical progress for Bristol-Myers' drug could be especially devastating to Celgene, simply because Revlimid is so important to the company's sales and profits.
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With those risks in mind, a high earnings multiple seems a lot less justifiable. After several years of multiple expansion, I'm looking for a move back to around 13 or 14 times projected 2015 EPS of $9. That puts the stock in the $115 to $125 range, or as much as 30% below current prices.
Action to Take -->
-- Short CELG at prices down to $140
-- Set stop-loss about 10% above your entry price
-- Set initial price target at $125 for a potential 11% gain in six months
This article was originally published at ProfitableTrading.com:
This Overvalued Biotech is in Danger of Plummeting as Much as 30%