Wednesday, January 17, 2007

It is all in the DNA

2007 could be the year of the large biotech I feel. Having already taken a bite of Genzyme I have been looking at Genentech (DNA) recently.

DNA is a large biotech (market cap $90 billion) which makes cancer and immunology drugs. They are majority owned by Swiss healthcare giant Roche, who take care of the European sales so nearly all of DNA's revenue comes from the US.

DNA is on a 2007 PE of about 30 and EPS growth for 2007 is forecast to be in the range 25 - 30%. So the valuation seem reasonable.

In their last earnings call CFO David Ebersman came out with some mouth-watering statements:

"For 2007, we expect R&D expense to be approximately 18% to 19% of revenues as we continue to invest in our late stage pipeline and add new molecules and indications to the early pipeline."

Translation: though DNA are struggling to recruit at the speed that revenue is growing they are trying. They later clarify that the will not sacrifice recruitment standards just to grow quicker; absolutely the right decision in my mind.

"In 2007, we expect MG&A as a percent of revenues to be approximately 18% to 19% as we continue to grow our commercial and infrastructure groups more modestly than our revenues."

Translation: they also cannot and do not need to recruit MG&A staff at the same speed as revenue growth. Result: improving margins.

My favourite: "In 2007, we expect free cash flow to increase significantly relative to 2006, as cash from operations grows and capital expenditures should stay relatively flat at approximately $1.2 billion."

Translation: Investor heaven - free cash flow on the rise.

Another nice one: "For 2007, we expect to continue to repurchase shares to offset dilution from option exercises and to maintain a flat share count and Roche’s ownership above the 55.7% level."

No dreaded share dilution then.

It takes a lot of research to get a feel for the strength of the pipeline but there is a lot going on and DNA have some of the brightest scientists around so there should be plenty of new indications in the near and distant future.

DNA is absolutely a buy in my mind. It may go down in the short term but over 3 to 5 years it is hard to see how it can do anything but grow.

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