Name That Trade – $AMGN All-Time High

by Enis March 4, 2013 11:56 am • Commentary

I first wrote about my thoughts on AMGN in a CotD post a week ago.  In that post, I highlighted the importance of the $90 breakout level, stating my view going forward:

Now that the stock has broken above 90, what’s the trade?

I prefer to see how a stock acts on a long-term breakout like this one.  If the stock continues to run higher, that adds confirmation to the breakout.  At that point, I would hope for a pullback to near the $90 level for a long entry.  For now, it’s a wait and see, with the thought that a fat pitch might develop in the future.

Of course, that’s a trader’s mindset.  For a long-term investor, this is probably a decent stock to put away in the drawer and forget about.  One of the few in this market where that description fits.

AMGN actually broke back below the 90 level on Feb 26th, but has since made a new high, and I expect the 89-90 area to be very strong support going forward.

That’s the technical context, but what about the fundamentals?  

AMGN has had positive earnings growth in every year in the past decade (the lowest growth rate was 2% in 2011), an impressive record given that it includes the financial crisis.  The company has been a direct beneficiary of increased U.S. spending on health care, as 80% of its revenues are from the U.S.  From AMGN’s most recent annual report, its top products (which account for about 90% of sales) currently are:

  • Neulasta and Neupogen:  Stimulate the production of white blood cells to help fight infection
  • Enbrel:  inhibitor of tumor necrosis factor (TNF), a substance that plays a role in inflammatory diseases
  • Aranesp and Epogen:  Agents that stimulate the production of red blood cells
  • Xgeva/Prolia:  a human monoclonal antibody that specifically targets RANKL, an essential regulator of osteoclasts (the cells that break down bone)

Some of these products will be coming off patent in the next few years, exposing AMGN to some generic competition in the years to come.  However, in the meantime, AMGN’s pipeline has several drugs in phase 3, and most importantly, the company has shown an ability to continue to innovate in the past decade that bodes well going forward.

Analyst consensus estimates currently model 10-15% earnings growth in the next 2 years, with a drop off to around 5% earnings growth from 2015-2017.  For now though, AMGN’s principal products are safe from generic competition, and the near-term earnings outlook is robust.

The main concern is the increasing valuation.  Here is the 7 year chart of AMGN’s P/E:


[caption id="attachment_23258" align="alignnone" width="506"]7 year chart of trailing P/E in AMGN, Courtesy of Bloomberg 7 year chart of trailing P/E in AMGN, Courtesy of Bloomberg[/caption]

A main reason for the increase in the multiple over the last 6 months is that the broader market multiple has increased as well.  However, AMGN had 22% earnings growth in 2012, and is projected to have 11% earnings growth in 2013.  The stock also pays a 2% dividend, and is in a much less volatile business than most other major companies.  In that regard, I’d much rather pay 16x for AMGN than 15x for the broader market, which has had no earnings growth in the past year and has shown much more earnings volatility overall in the past decade.

Put it all together, and I want to get long AMGN on a move back to 90.  My preferred trade is likely to be a 90/95/100 call butterfly a couple months out.  I have considered outright call spread purchases, but AMGN is a $70 billion market cap health care company, so large moves are against the odds.  Selling puts generally doesn’t offer enough premium to be worth the risk, so a range trade centered on 3-5% appreciation over the next couple months makes more sense to me.  I am doing nothing now, but will pull the trigger if AMGN stock gets close to 90.