Chuck Jaffe's Stupid Investment of the Week: United Therapeutics
Conventional wisdom says that stockholders should act like the owners of the business they are.
That means investing in “good companies” with outstanding prospects, clean balance sheets, solid management, an understandable business where past success appears likely to continue, and more.
Find that good or great company and you may be on to a great stock.
Or maybe not, because some good companies get people so excited that they become overpriced to the point where they’re more likely to see a big downturn before they reach that “good company” pinnacle.
- Unusual motel sting casts wide net on illicit activity
- Amanda Knox murder conviction overturned by Italy high court
- Priced out? Growing numbers appear to be fleeing King County
- 5 Seahawks takeaways from the NFL League Meetings
- Italian court throws out Knox conviction once and for all
Most Read Stories
That appears to be the case with United Therapeutics, which has investors excited for good reasons, but whose stock has overheated to where it is now a Stupid Investment of the Week.
Stupid Investment of the Week looks at the concerns and conditions that make a security less than ideal for the average investor, and is written in the hope that spotlighting trouble spots in one case will make it easier to sidestep danger elsewhere. While obviously not a purchase recommendation, neither is the column intended as an automatic sell signal.
For United Therapeutics investors, the big danger would be in unlocking capital gains, as the stock is up more than 10 percent so far this year after rocketing nearly 80 percent in 2007. Big double-digit returns have been the norm with the exception of a 21 percent loss in 2006; the stock soared 97 percent in 2004 and 53 percent the following year.
Clearly, riding this stock on the way up has been brilliant; the question is whether those gains are a bit too big, and what happens next.
United Therapeutics develops therapeutic products for patients with chronic, life-threatening diseases, primarily cardiovascular issues, cancer and infectious diseases.
The company’s primary drug is Remodulin, which is used to treat pulmonary arterial hypertension, basically by keeping blood vessels open and working properly. The company is developing an inhaled version of this product that is in trial phase and expected to receive Federal Drug Administration approval in the spring of 2009, as well as an oral formulation for which new test data is expected this fall.
Second-quarter sales of Remodulin were up 33 percent, and with limited competition, there was no denying the excitement. Here’s a company with a sound balance sheet — investment researcher Morningstar gives the company a B grade for financial health — good profit margins and reasonable growth prospects.
The problem is that, after gaining more than 65 percent in the last 12 months, the stock has become priced for perfection. Now trading at roughly 60 times earnings, the stock’s P/E ratio is about three times higher than the average biotech firm, and while the “good company” aspect is clearly visible, anyone getting into the stock now — or deciding not to take some profits at this point — is assuming that United Therapeutics is going to achieve its best-case scenario.
Pay any attention to biotech and pharmaceutical stocks and you’ll know that bumps in the road are the norm, not the exception. One or two bumps and United Therapeutics could be in for a big fall.
Consider the FDA approval process, where delays are par for the course. The disappointment of a push-back in approval for the inhaled product is likely — based on several experts’ reading of the data, plus the typical trend — and would be a punch to the gut for the stock.
Even if the inhaled and oral variations of Remodulin are approved smoothly, there’s some reason to believe that they will not gain much market share, with the new products growing mostly based on taking business away from the existing intravenous product. The development of competing products, including generics, is likely to take a bite out of Remodulin growth next year too; other drugs in United Therapeutics’ pipeline are still in the early stages and don’t factor heavily into the picture.
“To get to the current price of about $107 per share, I have to put in the best-case scenario,” says Jason Napodano, who follows United Therapeutics for Zacks Equity Research in Chicago. “You put in typical business bumps for a pharmaceutical company, and anything luck-of-the-draw and you have a stock that should be trading in the $80s or less. … I don’t know why you want to buy a stock assuming the best-case scenario, rather than something that is priced realistically and has upside if the best things happen.”
One other possible positive outcome for investors would be a takeover, and the success of Remodulin may make United Therapeutics a likely candidate. That said, most industry watchers say potential buyers would likely wait for a pullback in the shares — or to at least see if the company hits those likely bumps in the road — rather than paying a premium from current high levels.
In good-company/bad-stock scenarios, one common outcome is for the stock to suffer a setback, drop down to where it is priced more realistically, and then move into the realm of a good company that is also a good stock to buy.
Napodano, who has a “sell” rating on United Therapeutics, is one who thinks that is a reasonable path to expect for the company.
“This would be a very easy research report to write with a ‘buy’ on it if the current stock price was $50 or $60 per share,” says Napodano, who expects the stock to drop to $82 a share in the next six months.
“At that point,” he adds, “you have a great story with upside left on it, rather than a stock where you have to hope everything is perfect, and where there’s not necessarily much upside from here.”
Chuck Jaffe is senior columnist for MarketWatch. He does not own or hold short positions in any securities covered by Stupid Investment of the Week. If you have a suggestion for Chuck Jaffe’s Stupid Investment of the Week or a comment about this week’s column, you can reach him at email@example.com or Box 70, Cohasset, MA 02025-0070.