Research Articles

Amgen’s Dividend Policy Has Ignited Their Stock

Chuck Carnevale - Friday, January 11, 2013

Founded in 1980, Amgen (AMGN) is the world’s largest biotechnology company with a current market cap of just under $68 billion.  However, in spite of its already large size, we believe that Amgen has ample room to continue growing their earnings at above-average rates into the foreseeable future.  Our optimism for future growth is predicated on several factors.  First and foremost, Amgen has a strong pipeline of potential blockbuster medicines, many of which are already in Phase III trials. We will highlight some of the major candidates later.

In addition to a strong pipeline, Amgen is utilizing its strong cash position, cash flow generation capability and its pristine balance sheet towards making strategic acquisitions that will expand its geographic reach and bring additional candidates into its pipeline. On December 10, 2012 Amgen announced that they acquired deCODE Genetics, a global leader in human genetics headquartered in Reykjavik, Iceland in an all-cash transaction of $415 million.

On July 5, 2012, Amgen announced the completion of the acquisition of KAI Pharmaceuticals, a privately held company based in South San Francisco acquiring candidate KAI-4169, a novel agent for the treatment of secondary hyperparathyroidism in patients with chronic kidney disease who are on dialysis. And on June 12, 2012, Amgen announced the completion of the acquisition of Mustafa Nevzat Pharmaceuticals, a privately held Turkish company expanding their reach into promising markets of Turkey and surrounding regions.

In addition to acquisitions and a strong pipeline, Amgen also recently announced that they will buy back $2 billion in shares as part of a total $10 billion authorized buyback program. Added to these catalysts for growth is Amgen’s commitment to intensifying its research and development program under the leadership of new CEO Robert Bradway. Therefore, we believe Amgen is well-positioned to continue growing their earnings which we believe is a key component for increasing shareholder value.

However, in our opinion the major catalyst attributed to its recently improving share price has been the initiation of a dividend in 2011, which is a rarity for biotechnology companies.  Furthermore, on January 3, 2013, Amgen announced that they will increase their dividend by 31% to $.47 per share.  Consequently, Amgen’s PE ratio has expanded from approximately 11 times earnings prior to the initiation of their dividend to over 13 times earnings today, we see this as the beginning of a longer-term trend.  Therefore, an increasing earnings base coupled with PE expansion and a rapidly increasing dividend all indicate above-average future returns for both the short-term to the long-term time horizon.

F.A.S.T. Graphs Historical Analysis of Amgen

An analysis of Amgen’s historical business success utilizing the fundamentals analyzer software tool, F.A.S.T. Graphs, reveals a great deal about Amgen and how the market has treated its operating results.  Our first graph plots Amgen’s earnings per share growth (the orange line) and dividends only since calendar year 1993.  Here we discover that Amgen has been able to consistently grow its earnings at the high rate of 17% per annum.  The green shaded area represents cumulative earnings, and the light blue shaded area represents dividends paid out of those earnings.  Consequently, the initiation of a dividend policy is vividly expressed (Note:  All F.A.S.T. Graphs™ include one year of forecasting for 2013).

This next graph brings in monthly closing stock prices (the black line) in order to reveal the earnings and price correlation and relationship.  There are several important aspects regarding how the market has treated Amgen shares over this two decade history that we believe are very interesting.  First we discover that from 1993 to 1998, Amgen’s stock price closely tracked and correlated to its earnings justified valuation (the orange line). Then as we entered what was dubbed the irrational exuberant period commencing in 1999, Amgen’s share price became disconnected from its earnings.  Interestingly, Amgen’s stock price remained overvalued until the Great Recession of 2008 brought its shares back to economic reality and then to below intrinsic value.

From 2008 to 2011, Amgen share price languished in undervalued territory, even though operating results continued their upward trajectory. This quickly changed after they initiated their first dividend (the blue shaded area).  Since that time, Amgen’s share price has been rapidly moving back towards alignment with its earnings justified value. Consequently, we believe that the dividend is serving as the primary catalyst behind Amgen’s strong share price performance in 2011 and 2012. We will calculate and reveal these results later in this analysis.

Whenever we analyze a business utilizing the dynamic F.A.S.T. Graphs, fundamentals analyzer software tool , we always start with our longest time frame of 20 years, and then continue to run graphs with progressively shorter time periods.  This process allows us to ascertain whether a given company’s growth rate is accelerating, decelerating or staying the same.  Although we believe that the most relevant information will be found within the shorter time frames, we also believe that there is a lot of value in analyzing the company’s long-term historical results as well.

With that said, our next graph looks at Amgen since calendar year-end 1999.  It’s important to note that 1999 and 2000 represented the pinnacle of irrational pricing by Mr. Market. Therefore, we discovered that Amgen’s stock price was virtually range-bound for the better part of seven consecutive years.  Excessive valuation kept the stock from advancing even though the company’s earnings were growing rather nicely.  However, the most important takeaway from graphing this shorter time frame is that Amgen still averaged 14.6% per annum compounded annual earnings growth.

This next graphic looks at Amgen over the past decade.  Here we discover that the company’s earnings growth had re-accelerated to 16.5%, which is very close to its 20-year average of 17%.  We believe this is a remarkable achievement by what has now become a very large enterprise.

At this point, we thought it would be interesting to evaluate Amgen’s performance since calendar year 2003.  Remarkably, even though the company was significantly overvalued at the beginning of 2003, shareholders were able to closely mirror the performance of the S&P 500 thanks to the company’s strong earnings growth rate overcoming its high valuation. This is true even though we would classify the shares as currently undervalued.  In other words, this fast-growing company’s performance generated a positive rate of return even though the shares are overvalued at the beginning of the time period and undervalued at the end.

As we continue our process of reviewing shorter and shorter time frames, it is interesting to see how Amgen performed since the throes of the Great Recession of 2008. Amazingly, Amgen was capable of generating an average 11% compounded annual earnings growth rate. However, the most interesting aspect of this time period analysis is that the company’s shares were moderately undervalued, thanks to the Great Recession, during most of this time frame. However, share price did trend upwards along with earnings.

When you evaluate the performance of Amgen when the company’s stock price was not impaired with the headwinds of overvaluation, shareholders were able to harvest the company’s exceptional earnings growth achievement. Moreover, strong earnings growth coupled with attractive valuation allowed shareholders to earn a very attractive 14% per annum compounded rate of return during a time when the S&P 500’s performance was very weak.  Thereby illustrating that a strong above-average company purchased at a sound valuation can dramatically outperform the averages.

Our final set of graphics looks at Amgen since the company instituted a dividend policy.  Once the dividend was established, the gap between the company’s stock price and its earnings justified valuation has been rapidly closing. Moreover, we believe there is still room for Amgen’s shares to run over the short-to-intermediate term based on accelerated earnings growth and the announcement of the 31% increase in the quarterly dividend.

We feel it is more than coincidental that Amgen’s performance has accelerated to such a great extent after it started paying its dividend.  Clearly, as depicted by the performance results and dividend cash flow table below, much of Amgen’s significant outperformance can be attributed to undervaluation and strong earnings growth.  However, we would argue that now that the company is paying a dividend, it is beginning to broaden its appeal to other sets of potential shareholders.  Currently, we contend that Amgen offers attractive valuation, above-average potential growth and an above-market and rapidly growing dividend, representing a nice kicker to its total return potential.

The Near and Longer Term Future

We believe that fair value based on capitalizing earnings at a reasonable 15 PE ratio implies that Amgen’s stock is worth approximately $99 a share.  Furthermore, we believe there is a high probability that Amgen’s PE ratio could easily expand beyond our 15 PE target. But more importantly, we think the recently instituted dividend, representing an above-market yield, greatly minimizes downside risk.

The following estimated earnings and return calculator is based on the consensus five-year earnings estimate of 59 analysts reporting to Standard & Poor’s Capital IQ. We consider these estimates on the conservative side and somewhat biased towards expectations for calendar year 2013.  Longer term, we believe that Amgen has the potential to grow earnings at low to mid double-digit rates into the foreseeable future.  Amgen’s strong pipeline and intensified commitment to research and development, coupled with a pristine balance sheet capable of funding acquisitions and share buybacks supports our thesis for strong future growth.

Biotech: A Brief Introduction

Amgen is a biotechnology superstar engaging in pioneering science with the potential for delivering vital medicines.  According to Amgen, in 1919 Karl Ereky, a Hungarian engineer, coined the term “biotechnology” to describe the interaction of biology and human technology. The biotechnology industry differs from its chemical pharmaceutical counterparts because it is based on living organisms. The pharmaceutical industry has traditionally manufactured drugs which were synthesized from chemical compounds.  The biotechnology revolution created a new class of drugs referred to as the biologic.

Biologics are therapies derived from living organisms and include proteins, DNA vaccines, monoclonal antibodies, peptides and experimental modalities such as gene therapy, stem cell therapy, antisense nucleotides and RNA viruses. At the core, all cells have common processes they perform in order to survive, and biotechnology harnesses these processes to make products to treat illnesses and improve people’s health.

Amgen’s Products and Pipeline

Amgen has built their franchise on the strength of their 10 marketed products.  Originally, EPOGEN and NEUPOGEN, their two important blockbuster erythropoiesis-stimulating agents (ESAs) generated most of their revenues and profitability.  However, they have significantly expanded on this franchise thereby generating significantly greater revenues and profitability. The following slides taken from Amgen presentations summarize the company’s view of the future.  First and foremost is their commitment to expanding their core business and current product portfolios.

In addition to expanding their current product portfolios, Amgen has several promising candidates in late stages of development in their pipeline.  As we will soon address, developing biologic therapeutic compounds is a very expensive and time consuming process. Commercial success is highest for candidates in Phase 3.  As can be seen from the following slide, Amgen has several promising compounds in Phase 3, as well as several that are moving through Phase 2 testing.

Acquisitions

Amgen’s recent acquisitions provide them multiple opportunities for growth and expansion.  In addition to enlarging their geographical reach, the company is also acquiring promising candidates and R&D capabilities and opportunities.

Returning Capital to Shareholders

In the beginning, Amgen was a pure growth stock that required all of their capital to fund their long-term growth initiatives.  However, in recent years, as the company has grown they are becoming a much more shareholder-friendly enterprise. The following corporate slide summarizes Amgen’s current commitment to returning capital to shareholders.  Their focus on growing the dividend is a significant milestone in the company’s maturity and development.  Consequently, we believe that Amgen is evolving from a pure growth stock to an above-average growth and income investment.  Therefore, we believe the company is attractive for investors seeking growth as well as investors seeking current income.

Amgen’s Moats

One of Amgen’s strongest moats is their size and scale.  According to a BIOFACT that they present in their pamphlet -An Introduction to Biotechnology- Amgen states as follows:

“To bring a new drug to market (from discovery through clinical trials and FDA approval) cost an estimated $1 billion and can take 10 to 15 years or longer.  Only one in 10 new drugs that makes it into human testing actually makes it to market.  Given this high failure rate and the tremendous cost of bringing a new therapy to market, companies depend on successful drugs to produce enough revenue to compensate for both the R&D cost of the successful therapies and the expense of the failed ones.”

Clearly, Amgen is one of the few companies in the biotechnology industry that is capable of investing the levels of capital and resources necessary to bring a candidate to market.  Consequently, many smaller firms are often forced to partner with Amgen because they lack the resources necessary to commercialize their candidates.

Advancing Science through Strategic Partnerships

With more than 100 active collaborations, Amgen is well-suited to be a partner of choice in the

human therapeutics business. With the capabilities and financial strength of a large company,

Amgen can offer partners the resources to support a potential new medicine as it advances from

lab to clinic to marketplace. At the same time, Amgen retains the agility and decisiveness of a

smaller biotech, with an unwavering commitment to science and patients.

Furthermore, Amgen has the capabilities to manufacture and distribute compounds that they and partners develop. The following is a brief summary of their manufacturing locations:

A Pioneer in Biotechnology Manufacturing

Assuring that Amgen medicines rapidly, reliably, and safely reach patients is the charge of Amgen’s

manufacturing, process development, quality, and distribution teams. Manufacturing therapies

based on proteins found in the human body is a complex and highly specialized activity. From

process development and clinical manufacturing to full-scale therapeutic protein production, Amgen

has built one of the industry’s largest and most reliable operations. Amgen operates manufacturing

facilities in California, Colorado, Rhode Island, Washington, and Puerto Rico.

Summary

Amgen’s legacy has been that of a fast-growing biotechnology growth stock.  However, more recently the company is evolving into a high-quality blue-chip dividend paying growth and income stock. On the other hand, since we are early in this process, the growth attributes of Amgen remain intact.  Nevertheless, we believe that its recent posturing as a more shareholder-friendly enterprise is serving as a catalyst for the market’s desire towards capitalizing Amgen shares at higher valuations going forward.  Therefore, the combination of reasonably well-defined continued growth, low valuation and more shareholder-friendly attitude by management are strong positives auguring well for short and long-term profits.

Moreover, the company’s recent settlement with the US government, 49 states and the District of Columbia removes a negative that we feel had been holding the stock price down.  The following headlines and link provide more information:

Amgen Finalizes Agreement Resolving Previously Announced Federal Investigations

$762 Million Agreement Covered by 3rd Quarter 2011 Charge

For those interested in researching Amgen deeper and faster, follow this link to a live fully functional F.A.S.T. Graphs on Amgen.   For more information on how to interpret FAST Graphs, click here.

Conclusions

Our short-term target price for Amgen is $99 a share, or approximately 12% above current quotations.  Our intermediate term forecast is approximately $115 a share, and longer term we expect double-digit compounded returns in excess of 13% per annum, including dividends.

Disclosure: No position at the time of writing.

Disclaimer:  The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.

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