Merrill biotech analysts see interest in sector ahead of second quarter earnings

By Ronda Fears

Nashville, July 11 - Biotech stocks are again in vogue, which is very uncharacteristic because a seasonal slow down is common during the summer, said Merrill Lynch & Co. biotech analysts Eric Ende and Thomas McGahren in a report Monday. Upcoming earnings may trigger even more interest, and the analysts suggested small-cap names in the sector may begin to outperform their larger counterparts.

"Given that key biotech indexes recently broke out to new three-year highs and the overall market is becoming less risk averse, the sector could continue to trade higher. Investors own biotech stocks specifically for these rapid, large moves," the analysts said in the report.

"When they occur, fund flows improve, driving further strength. Also, watch for a big increase in new stock supply with $8 billion of deals in the pipeline, including 11 IPOs, which may drive further interest in the group.

"In particular, smaller cap names, which have underperformed large caps by 20% during the last six months and 27% during the last year, could begin to outperform large cap biotechs."

The analysts also previewed their expectations for some key biotech names.

Amgen could beat

Amgen Inc. earnings may beat the consensus forecast of $0.72 based on strong product sales, particularly Aranesp and expense control. Management is likely to focus on its pipeline with pivotal data expected for panitumumab in colorectal cancer by fourth quarter and phase II data for AMG-162 in breast cancer related bone metastasis by year-end 2005. A foreign exchange benefit should occur in second quarter but currency exchange rates could adversely impact by under 1% in third quarter.

Merrill's price objective of $77 assumes that the multiple expands from 19 times to 23 times the bank's 2006 EPS estimate of $3.30 during the next 12 months as investor sentiment improves. The 23 times multiple is based on a price/earnings to growth ratio (PEG) of 1.5 times a long-term growth rate of 15%. A PEG of 1.5 times is in line with the average biotech multiple but below the pharmaceutical group average of more than 2.0 times.

Risks are lower-than-expected product sales, future pricing or reimbursement issues and unforeseen pipeline failures, the analysts said.

Biogen could miss

Biogen Idec Inc. could miss earnings expectations, unless expenses are well controlled, because of weaker than expected Avonex sales despite an 8% price increase in June. While foreign exchange rates may benefit second quarter sales by $6 million, Merrill analysts believe that element could reduce third quarter sales by $6 million.

Clarity on Tysabri, a multiple sclerosis drug in development with Elan Corp. plc, is not expected until the end of the summer. Biogen and Elan pulled Tysabri from the market in late February because as many as five patients in the treatment studies contracted a potentially fatal brain disease.

Celgene seen in line

Celgene Corp.'s earnings should be in line with the consensus estimated EPS of $0.13, as Thalomid U.S. sales have been flat based on NDC data, tracking just shy of Merrill's $93 million estimate. The next event in Revlimid's regulatory progress is a FDA advisory panel in the MDS 5q-population in September, followed by an October 7 PDUFA date.

Celgene is a profitable oncology-focused biotechnology company featuring a potential blockbuster franchise with Thalomid and Revlimid, the analysts added. Merrill said its price objective of $45 is based on 52 times (PEG 1.4 times, four-year compound annual growth rate of 36%) with a 2006 fully diluted fully taxed EPS estimate of $0.86. The PEG ratio is a discount to the historical biotech average of 1.6 times, reflecting regulatory risk, competition in the multiple myeloma and other markets and reimbursement issues, which could preclude shares from reaching the price objective.

Chiron seen be in-line

Chiron Corp. earnings should meet consensus of $0.17 with no surprises expected. The company may update investors about the FDA inspection of its Liverpool flu manufacturing plant to determine if Fluvirin can be sold during the 2005/2006 flu season.

Last year, Chiron missed the flu season because its vaccine plant was closed due to safety issues with British regulators.

Eyetech's picture unclear

Eyetech Pharmaceuticals Inc.'s picture is less clear, the analysts suggested.

Macugen sales may beat consensus based on stronger than expected demand but they said the key stock driver is likely to be Lucentis data - in development by Genentech and partners - which will be released on July 18 in Montreal.

If the data suggests anything less than stellar efficacy or safety, Eyetech could rally as investors begin to believe that Macugen could have life after Lucentis.

Genentech may beat

Genentech Inc. earnings, meanwhile, should beat consensus of $0.26 per share based on strong sales of Avastin and Herceptin as well as lower than expected spending, that is, excluding a one-time charge in cost of goods for canceling certain manufacturing obligations. The Merrill analysts believe reimbursement of off-label uses for Avastin in lung cancer and Herceptin in adjuvant breast cancer are occurring and could drive higher than expected sales in 2005.

After the market close Monday, Genentech announced earnings of $0.30 per share, or $0.27 per share on a GAAP basis.

Merrill's price objective is $95 per share, based on a P/E of 54 times (PEG ratio of 1.65 times their anticipated 33% long-term growth rate) their 2006 EPS estimate of $1.79. The PEG ratio of 1.65 times is a premium over the 1.44 times average 2006 PEG ratio for 10 profitable biotechnology companies because we believe DNA has lower risks related to the development and commercialization of their products and there is potential for significant upside if Avastin succeeds in additional indications.

The analysts acknowledged their valuation and growth prospects for Genentech faces several key risks.

"Multiples have been adjusting across pharmaceutical and biotechnology stocks over the last several quarters to reflect a more conservative FDA environment and increased risk related to product approvals and recalls," they note. "Although Genentech has historically traded at a premium to its peers, if investors perceive that the regulatory environment may remain risky, multiples may remain at current levels or contract, affecting valuation."

Long-term growth of EPS depends on physician adoption of its oncology drugs across multiple indications and may also depend on reimbursement decisions, the analysts said. They believe growth should continue to accelerate with the approval of additional applications for Avastin and expanded use of Herceptin for adjuvant breast cancer. But if the FDA or Medicare or other insurers fail to approve label expansion or reimburse use of Genentech's drugs, growth estimates may be at risk.

In addition, if drugs in the pipeline such as Lucentis see negative data from ongoing trials, are delayed or do not meet current expectations if approved, growth estimates may be at risk. Additional pipeline products may face unforeseen competition from drugs in other companies' pipelines or other drugs currently on the market.

The impact of Medicare reimbursement changes is still evolving and may affect pricing and prescription habits of physicians, the analysts said.

Genzyme should meet targets

Genzyme Corp. earnings should meet consensus of $0.53 per share based on a currency exchange rate benefit while Renagel sales in the United States may disappoint due to competition. While a weak dollar may help second quarter sales, with 31% of product revenues outside the United States, third quarter sales may be hurt by $8 million to $10 million due to a stronger dollar.

Data from the DCOR study comparing Renagel to calcium-based phosphate binders could become available, but the analysts said the data may only show trends.

Gilead may beat big

Gilead Sciences Inc. earnings could be well ahead of consensus of $0.36 per share. Merrill analysts raised their U.S. sales estimate for Truvada to $112 million from $102 million but said Viread and Emtriva sales may be slightly weaker than expected.

The company is likely to raise 2005 HIV drug sales guidance to over $1.3 billion from $1.225 billion to $1.275 billion, the analysts said, noting that analysts' consensus is already at $1.32 billion. While a weak dollar may help second quarter sales, with 45% of product revenues outside the United States, third quarter sales may be adversely impacted by currency exchange rates.

Icos sales may disappoint

Icos Corp. sales may be a disappointment, the Merrill analysts said. Based on NDC data, it appears U.S. Cialis sales are tracking ahead of their $75 million estimate but with continued inventory draw downs, sales may not beat estimates.

ImClone overhangs linger

ImClone Systems Inc. earnings should meet consensus of $0.33 per share. Based on NDC data, Erbitux sales are tracking at $96 million, which is slightly ahead of consensus of $93 million. Merrill raised its EPS estimate to $0.32 from $0.26 based on higher manufacturing revenues from Merck KgA.

But, the analysts said they remain cautious on the long-term prospects of Erbitux due to competition.

MGI confidence in offing

MGI Pharma Inc.'s Aloxi sales appear to be tracking below consensus of $62 million due to competitive rebating by Zofran, but the Merrill analysts said they remain confident that Dacogen will be approved by Sept. 1 for myelodysplastic syndrome, driving the next leg of revenue and EPS growth.

Merrill's $32 price objective is based on a P/E multiple of 34 times (PEG ratio of 0.95 times projected five-year growth rate of 34%) off a 2006 fully taxed EPS of $1.01. The PEG ratio of 0.95 times, a 33% discount to the group, reflects development risk of Dacogen, Saforis and Zyc101a.

MGI Pharma faces several key risks in reaching the price objective, the analysts acknowledged.

First, the competitive landscape for Aloxi sales is evolving and Aloxi may not maintain or increase market share or revenues. The clinic and physician is very sensitive to discounts and reimbursements, as evidenced by Zofran's recent market share gains, the analysts said. Continued discounting for Zofran or other antiemetics may hurt Aloxi sales. In the hospital setting, generic antiemetics, such as generic Zofran, are expected to launch in 2006 and may temper Aloxi market share growth.

Aloxi pricing has declined due to recently signed new contracts resulting in bulk discounted purchases as well as the company providing discount to first time buyers. Pricing is expected to continue to decline through the middle of 2005. In addition, the company may provide payment term incentives to purchasers.

Key near-term risks for the pipeline include failure of Dacogen to receive FDA marketing approval. While Dacogen met one of its two co-primary endpoints in the phase III study of myelodysplastic syndrome, the FDA may not agree with the company's data analysis and may not grant approval or decide further trials are necessary.

Millennium sales ahead

Millennium Pharmaceuticals Inc. could be a slight upside surprise, the analysts said. Based on NDC data, Velcade sales are tracking ahead of their $44 million estimate and consensus of $46 million. Merrill expects EPS loss of $0.08, marginally better than consensus EPS loss of $0.10.

OSI pinned to Tarceva

OSI Pharmaceuticals Inc. could see an unprofitable quarter, the analysts said, but they raised their second quarter U.S. sales estimate for Tarceva to $65 million from $57 million, which is modestly ahead of consensus. They also raised their 2005 Tarceva sales projection to $269 million from $254 million.

Merrill's price objective of $54 is based on a net present value assessment of OSI Pharma marketed and pipeline products, including cash. Risks to its price target are lower than expected peak sales of Tarceva in the United States and the rest of the world, unfavorable rulings from the FDA on label expansion into additional indications, unfavorable results in clinical trials for cancer and diabetes programs, potential competition and unanticipated negative results for other proprietary products.

Protein Design royalties boost

Protein Design Labs Inc. is expected to be modestly profitable in the second quarter, meeting or beating the consensus EPS of $0.05 but Merrill analysts said this would likely be due in large part to the seasonality of royalty revenue related to Synagis and the addition of ESP Pharma product sales. They do not expect profitability for the remainder of the year.

Merrill's price objective of $26 is based on a NPV valuation of PDLI products, royalty revenue stream and pipeline products, excluding cash. The analysts estimate that royalties and licensing revenue derived from its humanization platform contributes about $13.50 per share in current value and that sales of ESP Pharma's products add another $6 per share. They also estimate that pipeline candidates from both its proprietary pipeline and ESP Pharma add about $7 per share of current value.

Risks to the potential profitability and the price target, the analysts said, include competition for products that provide royalty revenue, failure to successfully commercialize pipeline candidates and failure of the company's patent estate to protect its technology and royalty revenue base

Amylin loss may narrow

Amylin Pharmaceuticals Inc. could post a narrower loss than expected.

Merrill estimates Byetta sales of $1.9 million, but notes the drug was launched only a month ago and reported sales may exceed the estimate due to stocking. The analysts estimate an EPS loss of $0.26 per share, modestly better than consensus loss of $0.30.

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