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Vertex Pharmaceuticals Incorporated (NASDAQ:VRTX) has shined bright within the biotech industry this year. VRTX stock has more than doubled over the past 12 months. That stands in stark contrast to the sector, which in general has struggled due to high valuations and political uncertainty regarding healthcare reform.
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2017 was already shaping up to be a good year for Vertex shareholders. Then the company added more fuel to the fire last month, with new drug data results coming in favorably.
This positive event led to a large number of bank analysts upgrading the stock. VRTX shot up as much as 25% on the news. From today’s price, is there more upside ahead? Or as one contrary analyst warned, have investors already fully valued VRTX stock?
VRTX Stock Cons
Not Very Profitable: Vertex has done amazing work for sufferers of cystic fibrosis. But as often can happen in biotech, that hasn’t necessarily translated to a windfall for shareholders. VRTX stock trades at more than 100x trailing earnings; that’s far above the biotech industry median.
In its most recent earnings presentation, the company offered the following 2017 guidance. It suggests the company will generate between $1.8 billion and $2.1 billion in cystic fibrosis revenues. That is contrasted with between $1.8 and $1.9 billion in R&D and administrative spending. That leaves a scant profits, let’s call it $100 million or so, for shareholders. It’s hard to support Vertex’s current $39 billion-plus market cap on that scant level of profitability. Earnings are anticipated to grow next year, but not by a huge amount; VRTX stock still trades with a 50x forward PE Ratio.
How Much Market Opportunity Is There? Vertex’s defenders will say that the company has plenty of growth ahead, as it can treat more types of cystic fibrosis going forward. However, according to the Wall Street Journal, the company’s currently approved treatment options already work for half of the patient community.
This leaves us with a problem. If the company is only marginally profitable while already treating half of the outstanding patient community, how much money can it make in the happy event that it is able to treat everyone afflicted with cystic fibrosis? If revenues double to $4 billion and every dollar of that increased revenue went straight to earnings, VRTX would still sport around a 20x P/E ratio. Since drug patents don’t have long lifespans, investors discount drug revenues fairly steeply. Thus, 20x earnings several years out in the future if all goes to plan hardly inspires.
UBS Has Valuation Concerns: While most analysts applauded Vertex’s recent data, there was one sharp dissenting note. UBS’ Carter Gould downgraded VRTX stock to neutral last month, suggesting that it’s simply run up too much.
His $174 price target would still offer modest upside, but it suggests full valuation is near. Gould acknowledges that the company’s cystic fibrosis revenues could hit as high as $8 billion if the bull case plays out, even considering that in addition to the company’s cash and pipeline, and he still doesn’t see the stock as being worth $200/share or more. And biotech is a tricky business, drugs sometimes fail for unexpected reasons. And competitors such as Galapagos NV (ADR) (NASDAQ:GLPG) are researching their own cystic fibrosis drugs that could take a bite out of Vertex’s market.
VRTX Stock Pros
More Growth Ahead: Vertex has already delivered great growth in its cystic fibrosis franchise over the past couple of years, going from zero to $2 billion in revenues. Analysts, on average, forecast that the company will hit $6 billion in revenues in the year 2022.
This comes from several factors. For one, the company’s new triple combo therapy is expected to increase its addressable market from 50% of cystic fibrosis patients today to 90% in the future. Also, the new therapy will likely deliver better clinical outcomes, thus motivating patients to take their medications more frequently. That reduces the impact of slow or entirely neglected prescription refills. Finally, price hikes should give Vertex more room to grow revenues.
Long Revenue Cycle Ahead: Though it is hard to justify Vertex’s valuation on a near-term profit basis, it should earn blockbuster revenues from its cystic fibrosis business over a long period. Unlike, for example, Gilead Sciences, Inc. (NASDAQ:GILD) with its Hepatitis C cure, Vertex can keep selling its drugs to the same patients for many years.
The need for ongoing care means that many patients will provide revenues for the company right up until patent protection expires and generics come to market. There is always the risk of competitors coming to market with better drugs. However, given that the total patient population consists of fewer than 100,000 people, it’s likely too small a target to attract many peers as long as Vertex’s drugs are effective and safe.
Most Analysts Favorable: While UBS reacted to the recent trial data with a downgrade, it was in the distinct minority. In the days following the data readout, numerous analysts upgraded and/or raised price targets for VRTX stock.
Raymond James, Janney, Barclays and Cowen all upgraded the stock. Cowen’s take is most favorable for VRTX stock — they suggest that it is worth $200/share today given the favorable results reported last month.
Verdict
There’s no denying that Vertex has succeeded greatly with its R&D program, and they deserve respect for that. However, there’s a difference between good science and a high-probability investment.
It’s hard to see how the company will be able to generate enough profit in coming years to justify its current near-$40 billion market cap. Even treating the whole cystic fibrosis community still wouldn’t necessarily make the math pencil out. If you want to take a bullish position on VRTX stock, I’d consider using an options position rather than just owning the stock outright. For example, consider the bullish options trade ideas described here by contributor Nicolas Chahine.
At the time of this writing, Ian Bezek owned GILD stock. He had no position in any of the other aforementioned securities. You can reach him on Twitter at @irbezek.
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