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Celgene Boasts Of An Impressive Pipeline

Summary

2014 was a great year for Celgene and 2015 is expected to be even better. The company's total net product sales will reach the range of $9-$9.5 billion this year.

Though the firm is facing lower sales of Vidaza, worldwide sales of Celgene's Revlimid and Abraxane (treatment for breast cancer) continue to grow at a fast clip.

It's great to see Celgene's management focus on the long haul. The company's 2017 and 2020 financial targets are encouraging.

Let's dig into the firm's investment considerations as we walk through the valuation process and derive a fair value estimate for shares.

Celgene's Investment Considerations

Investment Highlights

  • Celgene (NASDAQ:CELG) is a biotech firm focused on developing therapies to treat cancer and immune-inflammatory related diseases. The company's product pipeline - which covers the areas of hematology, oncology, and immunology - is impressive. Revlimid, a treatment for multiple myeloma, accounts for more than half of sales.
  • 2014 was a great year for Celgene and 2015 is expected to be even better. The company's total net product sales will reach the range of $9-$9.5 billion this year, more than a 20% increase, with strong growth across the portfolio. Adjusted diluted EPS is expected to be $4.75-$4.85 (was $4.60-$4.75).
  • Though the firm is facing lower sales of Vidaza, worldwide sales of Celgene's Revlimid and Abraxane (treatment for breast cancer) continue to grow at a fast clip. Abraxane's net sales, for example, are expected to grow by more than 30% in 2015. The firm's prospects were enhanced by the approval of Otezla (psoriatic arthritis). Celgene continues to advance its pipeline.
  • It's great to see Celgene's management focus on the long haul. The company's 2017 financial targets are encouraging: $13-$14 billion in net sales and adjusted diluted EPS of ~$7.50. For 2020, management is looking for $20+ billion in sales and adjusted diluted EPS of $12.50+. Its Hematology franchise is the key driver.
  • As for risks, the areas of oncology, inflammation, and immunology are highly competitive. Numerous biotech firms are focused in these areas. This could either mean merger opportunities or heightened innovation and drug obsolescence risk (generics).

Most Recent Quarterly Update

Celgene's second-quarter results revealed a firm that is growing like few others. Product sales advanced 22% on a year-over-year basis, and the company levered that increase into a 36% increase in adjusted net income. Revlimid, Pomalyst/Imnovid, Abraxane, and Otezla were the primary drivers behind the fantastic showing. Revlimid's sales alone came in at ~$1.45 billion in the quarter, increasing 19% on a year-over-year basis, thanks to the longer duration of the therapy and continued share strength in multiple myeloma. Revlimid is expected to account for more than 60% of sales in 2015.

Exceptional is perhaps the best word to describe the recent performance at Celgene. The firm continues to invest across its portfolio and recent deals with AstraZeneca (NYSE:AZN), Juno (NASDAQ:JUNO) and Receptos (NASDAQ:RCPT) should pave a nice runway of long-term growth. Celgene raised its 2015 adjusted earnings per share guidance to the range of $4.75-$4.85, showcasing the ongoing momentum of its business strength. The company gapped up significantly following its recent performance.

Pipeline Discussion

Celgene has tremendous growth opportunity across its three main segments. It expects total revenue to grow at a 19% CAGR through 2020, when revenue is expected to grow to greater than $21 billion.

The firm's existing products are expected to drive growth in its Hematology segment, where revenue growth of over $8 billion is being targeted by 2020. This growth will be driven by existing products, Revlimid and Pomalyst, and will be complemented by label expansions of existing products and multiple new opportunities.

The Oncology segment is expected to grow revenue by 'only' ~$2 billion by 2020. The majority of the growth will come through the expansion of uses for the drug Abraxane, a cancer-treating product that has been approved for use and is currently in late stage trials for the treatment of several additional varieties of cancer.

Celgene's Inflammation and Immunity (I&I) segment is poised for the most explosive growth as measured by CAGR over the next 5 years. The firm expects to raise its revenues in the segment from ~$70 million to over $4 billion via its psoriasis and arthritis treatment, Otzela, as well as several new products that will treat diseases such as lupus and Crohn's disease.

Business Quality

Economic Profit Analysis

From our point of view, the best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital with its weighted average cost of capital. The gap or difference between ROIC and WACC is called the firm's economic profit spread. Celgene's 3-year historical return on invested capital (without goodwill) is 58.3%, which is above the estimate of its cost of capital of 10.5%. As such, we assign the firm a ValueCreation rating of EXCELLENT.

In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate. Celgene is a fantastic economic profit generator.

Cash Flow Analysis

Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. Celgene's free cash flow margin has averaged about 33.4% during the past 3 years. As such, we think the firm's cash flow generation is relatively STRONG.

The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. At Celgene, cash flow from operations increased about 39% from levels registered two years ago, while capital expenditures expanded about 9% over the same time period.

Valuation Analysis

This is the most important portion of our analysis. Below we outline our valuation assumptions and derive a fair value estimate for shares.

Our discounted cash flow model indicates that Celgene's shares are worth between $110-$184 each. Shares are currently trading at ~$105, below the lower bound of our fair value range. This indicates that we feel there is significantly more upside potential than downside risk associated with the shares at this time.

The margin of safety around our fair value estimate is derived from the historical volatility of key valuation drivers. The estimated fair value of $147 per share represents a price-to-earnings (P/E) ratio of about 61.4 times last year's earnings and an implied EV/EBITDA multiple of about 41.5 times last year's EBITDA.

Our model reflects a compound annual revenue growth rate of 17.7% during the next five years, a pace that is higher than the firm's 3-year historical compound annual growth rate of 16.6%. Our model reflects a 5-year projected average operating margin of 52.2%, which is above Celgene's trailing 3-year average.

Beyond Year 5, we assume free cash flow will grow at an annual rate of 6.7% for the next 15 years and 3% in perpetuity. For Celgene, we use a 10.5% weighted average cost of capital to discount future free cash flows.

(click to enlarge)

Margin of Safety Analysis

Although we estimate the firm's fair value at about $147 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future was known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values.

In the graph above, we show this probable range of fair values for Celgene. We think the firm is attractive below $110 per share (the green line), but quite expensive above $184 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.

Future Path of Fair Value

We estimate Celgene's fair value at this point in time to be about $147 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart above compares the firm's current share price with the path of Celgene's expected equity value per share over the next three years, assuming our long-term projections prove accurate.

The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change.

The expected fair value of $200 per share in Year 3 represents our existing fair value per share of $147 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.

We like Celgene's long-term focus and feel that it has achievable financial targets for 2017 and 2020. The company's impressive product pipeline provides support for such aspirations and we expect the company to deliver in a big way.

However, Celgene faces significant competition in several of its key markets, but innovation and a disciplined R&D program should help to generate key new therapies. Biotech stocks are, in general, more volatile than the average stock, and drug companies have come under increased political pressure recently, but we're not expecting landmark changes in the landscape anytime soon.

Celgene is trading at a discount to our estimate of its intrinsic value and shares register a 7 on the Valuentum Buying Index, which reflects some of the concern related to market sentiment and political risk. We tend to prefer equities rated a 9 or 10. However, we think the company is worth watching closely in light of its fantastic fundamentals. Should its technicals turn, please don't be surprised if we include it in the Best Ideas Newsletter portfolio.

Performance

In the spirit of transparency, we reveal the performance of the Valuentum Buying Index, our stock selection methodology, in a case study of the ratings spanning September 2013 through September 2014. Higher-rated entities (6-10) have been shown to outperform lower-rated entities (1-5). Past results are not a guarantee of future performance. Thank you for reading!

This article or report and any links within are for information purposes only and should not be considered a solicitation to buy or sell any security. Valuentum is not responsible for any errors or omissions or for results obtained from the use of this article and accepts no liability for how readers may choose to utilize the content. Assumptions, opinions, and estimates are based on our judgment as of the date of the article and are subject to change without notice. For more information about Valuentum and the products and services it offers, please contact us at info@valuentum.com.


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