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For Amgen, a Very Healthy Prognosis

By Frank DiLorenzo, CFA We at Standard & Poor's Equity Research Services see shares of Amgen (AMGN

; recent price, $55) as underpriced at current levels, considering what we view as its attractive valuation coupled with our expectation for solid sales and earnings growth. The stock carries Standard & Poor's highest investment recommendation of 5 STARS, or buy.

Amgen is the world's leading biotechnology company, with five drugs each posting over a billion dollars in annual sales. The company also invests more money in research and development than any other biotech concern. Growth since 2002 has primarily come from strong sales gains for Aranesp, a treatment for anemia; Enbrel, for rheumatoid arthritis (RA) and other inflammatory conditions; and Neulasta, used to decrease the incidence of infection in chemotherapy patients. We expect these drugs to continue to post solid growth into 2006.

In 2005, newer drugs, including Sensipar and Palifermin, should begin to contribute to Amgen's growth. While we believe Sensipar will eventually post up to $600 million to $700 million in annual sales, we think Palifermin and AMG 162, an experimental treatment for osteoporosis, have blockbuster potential.

A DOSE OF MARKETING. However, we expect Amgen to continue to operate in highly competitive markets. With Aranesp, the company must contend with Johnson & Johnson (JNJ

; $55) at home and both J&J and Roche abroad. For Enbrel, Abbott Laboratories' (ABT

; $39) Humira and J&J's Remicade are both formidable competitors. Sensipar's market also features a number of competing medications.

As a result of the competitive environment, Amgen must continue to execute its marketing strategies at a high level, in our view, as well as bring new products into the fold at a steady pace.

Amgen's anemia-treatment franchise consists of Aranesp and Epogen. Epogen is marketed in the U.S. for the treatment of anemia associated with chronic renal failure (CRF) in patients who are on dialysis. Aranesp is sold in the U.S. and European markets to treat anemia associated with CRF in patients who are on dialysis and patients not on dialysis. The drug is also indicated for the treatment of anemia associated with chemotherapy use. Epogen is dosed up to three times per week, whereas Aranesp is a longer-acting drug that can be dosed once per week or less frequently.

J&J VULNERABILITY. Aranesp's primary competition in the U.S. is J&J's Procrit. In Europe, the drug competes with J&J's Eprex and Roche's NeoRecormon. We project combined sales for Aranesp and Epogen of $4.9 billion for 2004 and $5.4 billion for 2005. We think our 2005 estimate could prove conservative.

Aranesp has benefited from weakness in J&J's Procrit/Eprex franchise. J&J's products have experienced sales declines over the past several quarters. We expect J&J's franchise to stabilize by 2005, but see Aranesp making additional gains through market-share growth.

Separately, Roche is developing CERA, a long-acting version of erythropoietin (EPO). If that is successful, we believe that CERA would compete against Amgen's Aranesp in Europe. We assume that CERA could be approved and sold in the EU market in 2007. We currently don't think CERA will be approved in the U.S. due to Amgen patents protecting its erythropoietin franchise. Amgen will lose European patent protection on its Epogen product by the end of 2005.

KEY FRANCHISE. However, Amgen doesn't market Epogen in Europe. Rather, J&J has rights to market erythropoietin as Eprex. We would expect any generic entrant to Epogen in Europe to primarily have an adverse impact on first-generation EPO products, such as Eprex. In our view, a generic first-generation EPO would not have a significant impact on Aranesp, which is a longer-acting, second-generation product.

Amgen's second major franchise includes Neupogen and Neulasta. Neupogen is indicated to decrease the incidence of infection in patients undergoing chemotherapy treatment. Neulasta is a long-acting version of Neupogen that can be dosed once per chemotherapy cycle, whereas Neupogen is dosed up to once daily. Both drugs are marketed in the U.S. and Europe and face limited competition. We forecast combined sales of these two drugs of $2.8 billion for 2004 and $3.3 billion for 2005.

Enbrel has been approved by the FDA for the treatment of moderate-to-severe rheumatoid arthritis, juvenile RA, psoriatic arthritis, ankylosing spondylitis, and moderate-to-severe chronic plaque psoriasis. Due to the broad number of diseases the drug is approved for, Amgen markets the drug by targeting both rheumatologists and dermatologists. Having most recently been approved to treat psoriasis in April, 2004, we expect this market to provide the greatest opportunity for growth through 2005.

STRONG LAUNCH. In RA, Enbrel's primary competition comes from J&J's Remicade and Abbott's Humira. Both of these drugs are also being tested for the treatment of psoriasis. While Enbrel has a head start in psoriasis, we expect Humira and Remicade to enter this arena within the next two to three years and be serious competitors. While Biogen Idec's (BIIB

; $57) Amevive and Genentech's (DNA

; $45) Raptiva are both approved to treat psoriasis, we don't view these drugs as significant competition for Enbrel. We project 2004 Enbrel sales of $1.8 billion, with 2005 sales increasing to $2.2 billion.

In March, 2004, the FDA approved Sensipar for the treatment of secondary hyperparathyroidism in patients on dialysis. According to Amgen, Sensipar is off to a good launch, with over 1,900 nephrologists having prescribed the medication. Moreover, approximately 75% of private health-care payors are covering the drug. We forecast 2004 Sensipar sales of $55 million and 2005 sales at $160 million.

The European Committee for Medicinal Products for Human Use (CHMP) in July issued a positive opinion for approval of Mimpara (Sensipar in the U.S.). We expect EU approval by the end of 2004.

BIGGER EXPECTATIONS. In June, Amgen filed for FDA approval of Palifermin for the treatment of oral mucositis in patients with hematologic malignancies that are also undergoing chemotherapy. The drug is also under review in Europe. We're assuming that Palifermin can get a priority six-month review from the FDA and be approved in the U.S. by the end of 2004. Globally, we think that Palifermin has the potential to reach $1 billion in peak annual sales by 2012.

We believe that Amgen has a strong pipeline that has been underappreciated due to the size of the company. If coming from a smaller firm, a number of Amgen's clinical candidates likely would draw significant investor appeal, in our opinion. However, due to Amgen's market cap, we believe it needs to deliver with a number of major new drugs over the second half of the decade to satisfy investor expectations. With Sensipar approved and our expectation for Palifermin approval, the company's R&D efforts have begun to bear some fruit, in our view.

We expect Amgen to commence Phase III trials of AMG 162 in third-quarter 2004. We believe that this compound for the treatment of osteoporosis could reach a peak annual sales level of well over $1 billion annually. Amgen is also developing AMG 114, a third-generation version of erythropoietin. This experimental candidate has an even longer duration of action than Aranesp, and may be able to be dosed once every two to four weeks. Amgen is initially developing this compound as a treatment for anemia in chemotherapy patients.

STRATEGIC ACQUISITION. We believe that Amgen's strategy of developing improved versions of FDA-approved drugs has been successful, with Aranesp and Neulasta both offering improvements over Epogen and Neupogen, respectively.

On Aug. 12, stockholders of biotech concern Tularik (TLRK

; $45) will vote on Amgen's proposed acquisition of the company for $25 per share. We believe that Tularik shareholders will vote for the acquisition. Considering the recent biotech correction, we think Tularik could very well be trading below $25 per share if not for Amgen's offer.

Although we think Amgen likely overpaid for Tularik, we consider the company to be a good strategic fit for Amgen's pipeline and we expect a smooth integration after the planned acquisition closes. We expect the deal to close in the third quarter, pending necessary approvals. Tularik's most advanced compound is T67, an experimental treatment for liver cancer that is currently in Phase III trials.

Based on S&P's Core Earnings methodology, we estimate earnings per share of $2.28 for 2004. We note that the company has issued significant amounts of stock options. While we believe that the issuance of options is high at Amgen, a potential requirement to expense options in the future would have less of an impact on Amgen's EPS compared to its peers, we believe. This is due to the fact that as a percentage of overall EPS, option expense is relatively low for Amgen in relation to other biotech concerns. The company continues to repurchase shares, with $1 billion in shares repurchased in the second quarter.

DISCOUNT PRICE. We project total revenues of $10.2 billion in 2004, $11.8 billion in 2005, and $13.2 billion in 2006. We estimate operating EPS of $2.40 for 2004, $2.90 for 2005, and $3.42 for 2006.

As of Aug. 5, Amgen shares were trading at 19.0 times our 2005 EPS estimate of $2.90. In comparison, the market-weighted average 2005 price-earnings multiple of S&P's biotech peer group was 33.6 (excluding Amgen). Using our four-year (with 2003 EPS of $1.90 as the base year) annualized EPS growth rate of 20.6% for Amgen, its 2005 p-e-to-growth (PEG) ratio was approximately 0.9 as of Aug. 5. This is a significant discount to our peer group average PEG of 1.4 (excluding Amgen). S&P's biotech peer group average annualized EPS growth rate is 24% through 2007 (excluding Amgen).

Based on our

discounted cash-flow analysis, our 12-month target price for Amgen is $80 -- well above the current price.

Key investment risks to our recommendation and target price of Amgen shares, in our view, include: disappointing sales of approved products; FDA rejection of Palifermin; clinical pipeline failures; a strong competitive environment for Amgen's products; negative regulatory, reimbursement and/or political developments with respect to the pricing and availability of health-care products and services and their reimbursement by the government and coverage by third-party payors; and ongoing and potential new litigation.

In addition, corrections in the overall market and the biotechnology sector in particular could have a negative impact on the share price. While there will be changes to Medicare reimbursement in 2005, we expect a minor negative impact to Amgen's product sales and believe our current 2005 EPS and revenue estimates reflect such potential effects. Analyst DiLorenzo follows shares of biotechnology companies for Standard & Poor's Equity Research Services

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