Analysts say competition, market saturation may slow Genentech's earnings growth

Genentech Inc. barely beat Wall Street estimates for the third quarter, and many analysts are skeptical that world's second-largest biotech company can maintain its scorching momentum amid new competition and a saturated market.

Genentech reported Monday that net profit in the three months ended Sept. 30 was $685 million, or 64 cents per share, up 21 percent from $568 million, or 53 cents per share, in the same period a year ago.

Revenue was $2.91 billion, up 22 percent from $2.38 billion in the third quarter last year.

Not counting expenses, including those related to the $919 million buyout of biotechnology company Tanox Inc. last quarter, the company earned $778 million, or 73 cents per share, up 22 percent from a year ago.

On that basis, which does not comply with generally accepted accounting principles, analysts expected Genentech to earn 72 cents per share on revenue of $2.93 billion.

Executives at the South San Francisco-based company said in a conference call Monday they were particularly happy about their $597 million in third-quarter sales of Avastin, which treats lung, breast and colon cancer. That's 37 percent more than in the year-ago quarter and several million dollars more than analysts had expected.

Genentech's partner on Avastin, Swiss health care giant Roche, received European approval for the drug as a treatment for certain forms of lung cancer. Genentech is seeking approval from the Food and Drug Administration to use Avastin as a treatment for metastatic breast cancer, or breast cancer that has spread to other parts of the body.

Genentech is also running tests to determine whether Avastin, also known as bevacizumab, is effective in "adjuvant therapy," the attempt to prevent the recurrence of a cancer after a tumor is surgically removed.

But biotechnology analysts say such new uses are incremental and Avastin may have already saturated its primary market.

"The double-edge sword of oncology is you get rapid adoption, but you tend to reach full saturation quickly," said Lehman Brothers equity analyst Jim Birchenough. He is forecasting net income growth of around 10 percent per year for several years — far lower than the 20 percent or more that many investors are hoping for, based on the company's relatively lofty stock price-to-earnings ratio.

Avastin — which the FDA approved in February 2004 as the first drug to thwart new blood vessels from developing and carrying nutrients to a tumor — is facing more competition.

Britain's GlaxoSmithKline PLC announced in March that its Tykerb was approved for treatment of patients with advanced or metastatic breast cancer who have received prior therapy. New York-based ImClone Systems Inc.'s Erbitux was also approved in 2004 to treat advanced colorectal cancer that has spread to other parts of the body.

Analyst Eric Schmidt said Genentech is relying too heavily on Avastin, the company's only drug with a year-over-year growth rate of at least 30 percent. Total U.S. product sales were $2.16 billion, up 18 percent from the third quarter last year.

"Avastin had good growth, but the others have hit a wall," said Schmidt, who works for equity research firm Cowen & Co. "The hope is that Avastin can lead the charge, but that's dependent on whether Avastin works in adjuvant therapy."

Genentech's second biggest source of revenue, Rituxan, approved to treat rheumatoid arthritis and non-Hodgkin's lymphoma, brought in $572 million last quarter. That's up 12 percent from than a year ago.

Sales of its breast cancer drug Herceptin rose 6 percent to $320 million.

Genentech's macular degeneration drug Lucentis, approved in June 2006, had sales of $198 million, a 29 percent jump. Lucentis is designed to inhibit the formation and leakage of new blood vessels in the back of the eye, the primary cause of central vision loss.

Sales of asthma drug Xolair increased 13 percent to $121 million. Xolair is designed to control asthma triggered by year-round allergens, and executives are bullish that the drug will soon be used to treat the growing incidence of pediatric asthma.

Genentech spent $578 million on research and development, up 38 percent from the third quarter of last year.

The company reaffirmed its outlook for full-year profit between $2.85 and $2.95 per share, excluding charges. Wall Street analysts were predicting earnings of $2.95 per share.

Shares of Genentech fell $2.46, or 3.17 percent, to close at $75.04 Tuesday.

Genentech is the biggest biotechnology company based on market capitalization, valued at $81.6 billion. It has a price-to-earnings ratio — a common measure of Wall Street's bullishness for a stock — of 31.8.

By contrast, Amgen's ratio is 16.6.