Should You Jump on This Biotech After Profit-Taking?

After a truly remarkable 20-month 650% gain, shares of Santarus have fallen by more than 20% since its all-time high in early August. While this performance may be meaningless, it might also mean that Santarus' rally has reached its end. Which is it?

Santarus at a glance
Santarus markets five drugs, using the "bunch of $100 million drugs versus one blockbuster drug" operational approach. In its most recent quarter, three of its five drugs saw double-digit growth, one was flat year-over-year, and the last drug launched this year. Combined, this created revenue growth of 89% year over year, which easily surpassed expectations.

Now, Glumetza -- used to help improve glycemic control in adults with type 2 diabetes mellitus -- is its biggest revenue producer, accounting for $44.4 million of the company's $89.4 million during the company's last quarter. However, Zegerid and Uceris are the ones that have taken Wall Street by storm and led to such mindboggling gains.

Zegerid treats heartburn, and prior to 2013 it faced generic competition from Par Pharmaceuticals. A major catalyst in 2012 was a court decision that ultimately gave Santarus exclusive rights to Zegerid. As a result, Zegerid sales for the first six months of 2013 have been $46.2 million, compared to just $18 million in 2012.

While the Zegerid news is nice, the real catalyst has been the success of Uceris. This drug, which treats mild to moderate ulcerative colitis, had very moderate expectations prior to its launch in the first quarter. In fact, management would hardly provide an outlook, and analysts forecast sales of $20 million for the entire year.

Uceris has already produced sales of $22 million in the first six months, however, and the tone surrounding this drug has completely changed. During the conference call, peak sales estimates of $500 million were discussed, which were far greater than the $300 million that were once considered a success.

Also consider Uceris' development into additional indications. Ulcerative colitis is the largest indication with 700,000 annual cases, a market that's expected to double by 2021. However, Santarus is also testing Uceris to treat microscopic colitis and pediatric UC, which combined is about half the size of the ulcerative colitis indication. The bottom line is that Uceris is a crucial piece of the Santarus puzzle.

What about valuation?
Back in the first quarter, Santarus said in its conference call that its five marketed products could produce peak sales of $700 million. That was before we knew of Uceris' success, however. Peak sales could be closer to $900 million, and that's not including additional indications or other pipeline products.

So, with a market cap of $1.4 billion, and $293.7 million in trailing-12-months revenue, Santarus trades at five times sales. On the surface this may look expensive, but when you consider peak product sales, is the stock really that expensive?

To answer that question, we can turn to other top-performing biotechs and their valuation relative to peak sales.

First, let's look at Pharmacyclics , and its market capitalization of $8.7 billion. The company's clinical product ibrutinib treats various forms of leukemia/lymphoma and is expected to earn approval from the Food and Drug Administration early next year.

The most generous of outlooks, from Goldman Sachs, peg peak sales for ibrutinib at $6 billion if all indications are FDA approved. Due to Pharmacyclics' partnership with Johnson & Johnson, sales are split down the middle, meaning that Pharmacyclics will only receive $3 billion if peak sales are reached. Thus, Pharmacyclics trades at nearly three times its share of peak sales.

Next, let's look at Ariad Pharmaceuticals , a $4 billion company that markets Iclusig for a form of leukemia. Like Pharmacyclics, Ariad is developing its drug to expand in use. The peak sales on this product vary because it has harsh side effects, including those of the liver and blood clots. The most generous of estimates are still near $1.5 billion if the drug is developed for other indications, however.

Therefore, Ariad is trading at nearly 2.7 times peak sales. Now, the reason that Ariad's valuation is significant is because Iclusig and Santarus' Uceris began selling at the same time. The only difference was that Uceris did not have high expectations. Nonetheless, sales in the first two quarters of 2013 for Iclusig were $20.4 million, which was less than Uceris.

Looking at the two companies, Santarus' Uceris is actually performing better. Santarus also has four other drugs along with being cheaper relative to peak sales. If we estimate that peak sales of Santarus' five products will reach $900 million following the success of Uceris, then Santarus trades at just 1.55 times peak sales. Thus, Santarus is significantly cheaper than both Pharmacyclics or Ariad. Moreover, because Santarus is already producing large revenue and profits, there is reason to believe that it is presenting great upside.

Final thoughts
If three times peak sales is the standard for biotechnology companies -- based on Pharmacyclics and Ariad -- then Santarus should trend higher until reaching a market capitalization of $2.7 billion. This would be a gain of almost 100% from this point forward. Therefore, I say that Santarus' recent pullback is just a bump in the road and not a serious threat of long-term loss. With that said, investors should keep this company on their radar. With Uceris' marketing success and Santarus' five clinical programs in development, this is a company with a lot of promise regardless of its short-term trend.

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The article Should You Jump on This Biotech After Profit-Taking? originally appeared on Fool.com.

Brian Nichols is long Santarus. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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