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Genentech Got It Done

Marc Lichtenfeld

To understand just why that is, one must understand that, as our own Justin Ferayorni put it, the key to Genentech's stock is Avastin, Avastin and Avastin. Quite simply, the drug is vital to Genentech's existing and future revenue. After all, there are currently 130 clinical trials being conducted involving 25 tumor types, according to the company. But for investors to focus only on Avastin is misguided.

U.S. sales of the colorectal-cancer fighter were short of expectations -- $423 million vs. the $439 million estimate. However, sales of the anticancer drugs Rituxan and Herceptin both came in above the consensus predictions, at $526 million and $320 million, respectively, compared with expectations of $503 million and $309 million.

Seemingly lost in the examination of the earnings report was the fact that Genentech boosted its full-year guidance to what would be the equivalent of roughly $1.98 to $2.05 a share. The previous consensus on Wall Street was $1.96. That's a 55% to 60% increase in earnings over last year's $1.28 -- not bad for a nearly 30-year-old company with expected revenue of almost $9 billion.

How to Execute

Genentech raised its guidance because of strong sales and improving margins. The cost of sales dropped to 16% from 22% a year ago, and the company expects that figure to remain the same through the rest of the year. Marketing, general and administrative costs dipped to 20% of sales from 23% in the year-ago period, and management believes MG&A will come in between 20% and 21% for the remainder of 2006.

This tells me that, while revenue is growing, Genentech's management is still able to exercise some fiscal responsibility. As sales increased, MG&A actually rose 23%, but as a percentage of sales, it dropped.

All of these positives to the income statement start at the top line with what was strong revenue, even with the soft Avastin sales.

Another way the company showed me it's able to execute was the shipment of $10 million worth of Lucentis on the day it was approved. On June 30, the Food and Drug Administration gave the green light to Genentech's treatment for wet age-related macular degeneration. Though it's not unheard of for a company to start shipping a product on the same day it is approved, it's not exactly the norm.

I certainly wouldn't have taken points away if Genentech took a little while to start moving the product out the door, but color me impressed on the execution.

I was fascinated that on the conference call only one question was asked of Chief Financial Officer David Ebersman. He even thanked the analyst for asking it because he "didn't want to go two calls in a row without a single question." No doubt that pipelines and trials are the lifeblood of biotech companies, but an impressive financial performance like Genentech's shouldn't be ignored.

Know the Horizon

A day after the quarterly report, shares of Genentech were down $2.82, or 3.4%, at $81.24, on trading volume that was nearly twice the daily average.

Why the selloff? It appears the reason the stock declined in after-hours trading was the revelation that the FDA may require additional data on Avastin before it's approved for treating breast cancer. Genentech has a Nov. 22 date with the FDA to review the findings of its trials. But because the company is studying a progression-free survival endpoint rather than simply survival, more documentation may be needed.

Avastin is already being administered to treat breast cancer in what is known as off-label usage, meaning the drug hasn't been approved for that disease. In fact, management stated that a large part of the growth of Avastin this quarter came from off-label uses. Even so, once the drug does is approved for breast cancer, "there will be significant upside" to it, according to Ian Clark, Genentech's executive vice president of commercial operations.

Along with the November appointment for Avastin, Genentech will go before the FDA on Aug. 17 with data on Herceptin for breast cancer (it's already approved for a specific type of breast cancer) and Oct. 11 with Avastin plus platinum chemotherapy for the treatment of nonsmall-cell lung cancer. Genentech will also soon start a couple of Phase III trials for rheumatoid arthritis and neuromyelitis optica, an inflammatory disease that strikes the optic nerve and spinal cord.

Shares of Genentech, at more than 40 times 2006 estimated earnings, aren't cheap. However, on a forward price-earnings-to-growth basis, the stock is trading at roughly one times growth.

Nevertheless, anyone with a long-term time horizon may want to wait for the speculators and weak hands to sell and let the shares come in a bit. At that point, investors will have the opportunity to pick up a leading biotech name that has proven it can perform.