Spotlight Back on Genentech

The biotech giant once again faces huge expectations from investors.
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These days, when

Genentech

(DNA)

reports its quarterly earnings, investors expect a blowout. Not numbers that meet or slightly exceed Wall Street's estimates, but results that show blazing growth.

After all, shareholders have adopted something of a sky's-the-limit approach to Genentech's shares, making the company the world's biggest biotech by market capitalization.

That being the case, holders have consistently high expectations, and for the most part, Genentech has delivered. Just how long it can keep up the pace is unknown, but on Tuesday Genentech will at least shed some light on its near-term expectations when it kicks off the earnings season for the biotech sector.

Citigroup biotech analyst Elise Wang says she's looking for Genentech's cancer drug Avastin to bring in $383 million in sales, a bit below the consensus estimate of $389 million. Avastin is approved to treat colorectal cancer, but it has been used off-label against breast and lung cancers, as well as an eyesight-diminishing disease called wet age-related macular degeneration.

"We believe investor expectations may be too high, which may weigh on the stock," Wang says.

Conversely, sales of Rituxan, Genentech's biggest seller, might be on the strong side, Wang says. She currently has an estimate of $494 million for the non-Hodgkin's lymphoma drug but said it might have had an even better quarter.

The reason is that her Rituxan forecast doesn't include any use of the drug for treating rheumatoid arthritis, a condition for which the Food and Drug Administration approved it during the first quarter. Genentech hasn't officially started selling Rituxan for rheumatoid arthritis, but doctors could have been prescribing it anyway, something the law allows them to do for a product that's been cleared for any one use.

For the breast cancer drug Herceptin, Wang says she wants to see sales of $287 million for the quarter, a $13 million increase from her previous estimate of $274 million. Citigroup has performed investment-banking services for the company.

Analyst John Sonnier of William Blair & Co. predicts that sales of both cancer drugs will contribute to better-than-expected results, especially from their use outside of currently approved indications. "To that end, we believe Genentech has more opportunity to exceed first-quarter expectations than its peers have," Sonnier wrote in a recent research report.

During its annual investor meeting last month, the biotech giant gave an upbeat forecast that sent its shares almost 7% higher in one day. Still, the stock has declined about 18% overall since early December.

Genentech doesn't provide quarterly estimates, but it said at the meeting that its adjusted profits in 2006 should grow 40% to 50% from last year, an outlook that implies a bottom line of $1.79 to $1.92 a share. For the most recent first quarter, analysts surveyed by Thomson First Call are estimating that the company earned 41 cents a share on sales of $1.96 billion.

Analyst Chris Raymond of Robert W. Baird thinks the company will beat those targets, but he feels Genentech's shares are fully valued at about 43 times 2006 earnings, compared with a 40 multiple for its peer group.

"While Avastin approval in lung and breast cancers along with

macular degeneration drug Lucentis approval could provide continued growth potential, we view these approvals as priced in at current levels and remain neutral," Raymond wrote in a research report.

Baird or its affiliates expect to receive or plan to seek investment-banking compensation from Genentech.

Genentech, and the biotech sector as a whole for that matter, is largely driven by short-term events, according to William Blair's Sonnier. "

We also maintain our belief that second-quarter medical meetings could bring increased visibility into potential competitors for Avastin and Herceptin, which could limit near-term upside in

Genentech shares," he says.

"On the competitive front, the biotechnology and pharmaceutical industries are also keenly focused on the development of new targeted drugs for use in the oncology setting, which may result in a developmental pipeline of competitive drugs," says Sonnier. "To that end, we anticipate key medical meetings in the second quarter could be net negative for Genentech."

Avastin's use in lung cancer and Herceptin in fighting breast cancer made Genentech the star of last year's meeting of the American Society of Clinical Oncology. This year's meeting is scheduled for June 2-6 in Atlanta.

Sonnier, whose firm has received or expects to receive investment-banking compensation from Genentech, also says the stock's valuation makes it "extremely vulnerable" to operational missteps, pullbacks in the sector and negative headlines, including positive news from competitors.