Should You Chase These Biotech Post-Earning Gains?
Alexion Pharmaceuticals traded higher by 5.25% after announcing third-quarter earnings. Sure, the company beat estimates, but at some point, valuation must be a concern.
A look at the report
Alexion Pharmaceuticals markets and develops Soliris, a drug that treats rare disorders by preventing the destruction or removal of invading particles by binding to a component called C5. So far, Soliris is FDA approved to treat a blood disease called PNH and a genetic disease called aHUS. However, the company is also testing Soliris to treat five additional diseases.
Despite Soliris treating rare orphan diseases, sales have been strong. In the third quarter, sales of Soliris were $400.4 million and its EPS was $0.83, both of which were better than estimates. Moreover, Alexion also noted that both patients in aHUS and PNH increased in the quarter and full-year Soliris guidance was slightly increased to $1.54 billion.
An alarming trend
While $400.4 million in quarterly sales is impressive, as is Soliris' 36% year-over-year growth, it further shows declining fundamentals. To explain, take a look at the chart below, which shows the last five quarters and Soliris' year-over-year revenue growth.
Quarter (Q) -- Year
Q2 -- 2013
Q1 -- 2013
Q4 -- 2012
Q3 -- 2012
Q2 -- 2012
Clearly, sales growth of Soliris is declining on a year-over-year basis. While this is alarming to some, many bulls will note that sales growth always declines as a product's annual revenue grows. Obviously, the bullish belief would be accurate, but the problem is Alexion's valuation and Soliris' expectations.
Alexion markets no other product but has a $22.5 billion market capitalization. Therefore, if we assume that Soliris produces sales of $1.54 billion in 2013, as guided, then Alexion trades at 14.6 times full-year sales. This massive valuation is based on a best-case scenario, one in which analysts believe that Soliris sales could top $4 billion if all five additional indications are eventually FDA approved.
If so, and $4 billion in sales are realized, Alexion would trade at 5.5 times peak sales potential, which is still significantly higher than the 3.2 times sales average in the drug industry space. Hence, all of Alexion's upside has been valued into shares.
Many might wonder why Alexion carries such a massive valuation despite the risk of needing future FDA approvals and decelerating growth. The answer lies in its orphan designation, providing more years of exclusivity, and the fact that no other product is FDA approved to treat any of Soliris' indications.
With that said, Celldex Therapeutics is developing a product called CD-1135 that is also a complement modulator. As I said, Soliris binds to the component C5, but CD-1135 also binds to C5 and also C3. Celldex has tested its product in several mice studies and has demonstrated control of C3. Most notably, CD-1135 controlled C3 and C5 in mice with damaged kidneys, a feat that no other drug had accomplished, including Soliris.
Celldex is scheduled to release human data on CD-1135 in treating dense deposit disease in the next couple months, and if successful, many believe that Celldex will attempt to treat diseases targeted by Soliris. As of now, trial results are merely speculative, but do pose a great risk to Alexion is successful.
In the case of Celldex, success could catapult shares of the stock even higher, but if negative, the company still has a large pipeline of cancer fighting products to fall back on. Thus, Celldex is well-protected, while Alexion is not.
There are better options!
Given the short-term risk of competition and the massive valuation awarded, I wouldn't feel safe investing in Alexion Pharmaceuticals. The fact of the matter is that investors need every single domino to fall in place for Alexion to return large gains, and in biotechnology, there is almost always a bump in the road at some point in time, whether it be a failed trial, slowed growth, or trouble with the FDA.
I'm currently a shareholder in Questcor Pharmaceuticals and see more opportunities for growth instead. Questcor markets Acthar, an orphan product, and like Alexion, grows revenue by expanding the use of Acthar. The difference is that Acthar has 19 different uses, and Questcor is growing significantly faster.
During Questcor's last quarter, sales grew nearly 65% year-over-year. Moreover, the company has operating margins of 55%, which continue to rise. With a market cap of $4 billion, Questcor trades at 6 times sales and just 11.5 times next year's earnings, compared to Alexion at 34 times next year's earnings.
Moreover, looking at the next five years, Alexion has a PEG ratio of 1.44 (1.0 is considered fair value based on earnings expectations), while Questcor's is just 0.5. Therefore, with all things considered, I personally decided not to take the risk and chase Alexion at these levels.
One growth stock to watch today
This incredible tech stock is growing twice as fast as Google and Facebook, and more than three times as fast as Amazon.com and Apple. Watch our jaw-dropping investor alert video today to find out why The Motley Fool's chief technology officer is putting $117,238 of his own money on the table, and why he's so confident this will be a huge winner in 2013 and beyond. Just click here to watch!
The article Should You Chase These Biotech Post-Earning Gains? originally appeared on Fool.com.Brian Nichols owns shares of Questcor. 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.
Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.