If you watched biotechnology stocks rally for the past few years without enjoying the ride, now’s the time to make up for lost ground.
The sector has been hammered, down to valuations not seen in years, but for reasons that don’t add up.
Meanwhile, this rout is different from the classic blowups of years ago, in that many biotech companies now are financially sound. They took advantage of higher prices in the past few years to raise capital.
“There are lots of good deals, especially in the small-cap space,” says Ron Garren, a practicing oncologist who writes the stock letter Biotech Insight. Garren, and all the other biotech experts cited below made the brave call to buy biotech on Wednesday, when the sector was in free fall. It rebounded the next day. But the stocks still look cheap because the selloff has been so dramatic.
Here’s why the group has been selling off, why the worries don’t make a lot of sense, and 10 stocks to consider buying.
Reason 1: There’s a lull in good news, but that’s temporary
The good-news drought is particularly troubling to biotech investors, because it’s happening on three levels. First, the flow of great product-launch news in the past few years, like Tecfidera from Biogen BIIB, +4.98% for multiple sclerosis, or Solvadi from Gilead Sciences GILD, +0.52% for hepatitis C, has ground to a halt.
“We’ve generally had a lack of big drug launches over the past 12 months,” says Paul Yook, a biotech expert who manages the BioShares Biotechnology Clinical Trials Fund BBC, +4.91% an exchange traded fund.
Second, there’s been a slowdown in headline-grabbing clinical trial news, plus some outright research gaffs, to boot. That’s happened recently at former biotech darlings like bluebird bio BLUE, +0.87% and Juno Therapeutics JUNO, +1.31% in gene therapy, and Biogen, among others.
Third, attendees at the annual “Woodstock” for health-sector investors earlier this week — the J.P. Morgan Healthcare Conference in San Francisco — were hoping to get the usual rounds of stock-moving news. Instead, it was a flop in this regard.
“There isn’t any spark,” said Brad Loncar, of Loncar Investments, during a break from presentations on Wednesday. “It is a business-as-usual year.”
Jeff Jonas, a biotech expert and portfolio manager at Gabelli Funds, echoed the sentiment: “In past years there were bigger deals announced. But this year it is more neutral.”
In short, biotech investors who are used to a steady diet of awesome news are famished. But this doesn’t mean the sector is dead. It’s just in a lull. Thanks to big-picture breakthroughs in our understanding of genomics, how cells communicate so that treacherous signal paths can be disrupted, and how to harness the immune system to fight diseases like cancer, the breakthrough research hits should keep on coming.
“The industry fundamentals are very sound,” says Loncar, who manages the Loncar Cancer Immunotherapy CNCR, +3.06% ETF. “The amount of innovation is tremendous. It is such a cool time to be involved in biotech.”
Citing estimates from IMS Health, a consulting group, Loncar thinks annual health-care and drug spending could rise almost 40% to $1.4 trillion by 2020 because of drug breakthroughs, the aging population in the developed world and greater health-care consumption in developing economies.
“The end-user demographics have never been more favorable,” he says. Cancer-drug spending may rise to $147 billion by 2018, from about $100 billion last year. “That’s just explosive growth,” says Loncar. “You have to look at the long-term potential. You can’t obsess about a month or six months. I think the fundamentals are very strong for biotech. We are just going through a rough patch.”
Reason 2: It’s risk-off time due to concerns about China, growth and the Fed
Whenever investors go into near-panic mode, they sell risk. Biotech fits the bill. So stocks in this sector get sold down hard. “There’s panic in the market overall, and everyone has left everything that is risky. This has nothing to do with the fundamentals,” says Garren.
But fears about China and Federal Reserve interest-rate hikes are probably overblown. And the appetite for risk will swing the other way, at some point.
One problem is that biotech earnings are typically in the distant future. But lots of funds are needed in the meantime for research. “When investors pull back from capital markets, that is concerning because it makes you think biotech companies will have trouble raising money,” says Loncar.
But biotech companies are actually pretty financially sound, for a change, so they can ride this out. They took advantage of higher stock prices in the past few years to raise funds via stock issues only, as opposed to riskier convertible debt. That’s one thing that makes this selloff a lot different from the big one in 2001-2002, says Yook. And even during the current mayhem, the financing window is still open. About a dozen companies raised capital recently.
“The balance sheets across the industry are exceptionally well-funded,” says Yook. His ETF, BioShares Biotechnology Clinical Trials, tracks 89 companies. They have over $2 billion in cash, and there’s virtually no debt.
“It’s a staggering sum,” he says.
Several biotech companies have been hit so hard, they are trading for around cash levels, such as Arbutus Biopharma ABUS, +2.42% “The bottom line is these companies have sufficient funding for their clinical programs. That is really important,” says Yook.
Reason 3: Drug pricing is still an issue
With Bernie Sanders catching up to Hillary Clinton in the polls, Clinton has had to shift her rhetoric to the left to combat him. This has biotech investors worried they will see another Clinton tweet on drug pricing, says Connor Browne, of Thornburg Investment Management. They have reason to worry. Her tweet on the subject last September shaved billions in market cap off the sector.
Already, some companies, like Biogen, are taking less aggressive price increases. Investors have noticed, says Yook.
The big picture, though: Action from Washington on drug pricing is unlikely, for reasons I outlined in a previous column.
The bottom line: Abusive price increases, like those from Martin Shkreli while he was at Turing Pharmaceuticals, are happening with a narrow group of older drugs. That makes it easy to isolate the practice from what goes on at biotech companies developing new therapies for unmet medical needs. Those will probably continue to command premium prices.
“I don’t think Congress is going to kill innovation by controlling prices on new breakthrough medicines,” says Garren.
How long will the sector weakness last?
Biotech stocks put in a nice bounce Thursday. Who knows if there will be follow through higher, or more selling. No one can call the exact bottom in a group. But sentiment is dire, which is favorable in the contrarian sense. Biotech stocks are cheap. And investor convulsions about China and Fed rate hikes might be simmering down. So this is a good time to buy.
How cheap? The big four in the space, or Gilead, Biogen, Amgen AMGN, +5.29% and Celgene CELG, +4.92% on Jan. 13 traded about as low as they have in over a decade, or at 13.8 times earnings, compared to 18 last July, points out Yook. “That’s remarkable,” he says. “Valuations have gotten silly, but the industry is healthy. The problem is, volatility begets volatility. You have investors who just can’t take the pain anymore.”
That’s often a great time to step in and buy.
Stocks to buy
What to pick up in the selloff? Consider some of these companies. Among large-cap stocks, Jonas, at Gabelli Funds, favors Gilead, which he says looks cheap at around 10 times earnings. He likes Gilead’s financial strength, which gives it an opportunity to make acquisitions in the ongoing weakness in the space.
“It takes some time for sellers to lower their expectations,” he says. “Now that we are six months into the decline, that’s starting to happen.”
He also likes Amgen, in part, because it has a great research pipeline in treatments for cardiovascular problems, among others. Loncar singles out Bristol-Myers Squibb BMY, +3.64% for its robust pipeline of anti-cancer therapies.
Among smaller-cap names, Yook favors Arbutus Biopharma, which is developing hepatitis B drugs, and Adaptimmune Therapeutics ADAP, +5.15% which has an innovative approach to treating cancer called TCR therapy.
“To be able to buy this stock at this level is pretty compelling,” he said Wednesday.
The stock advanced Thursday, but it still looks attractive. He also likes Anacor Pharmaceuticals ANAC, +4.10% which has treatments for eczema on the way, and bluebird bio, a former gene-therapy darling that managed to raise a lot of cash before its stock tanked.
Garren favors micro-caps, which have declined the most. Here he likes Celldex Therapeutics CLDX, +1.59% which he says has promising brain-cancer therapies on the way; and Oncothyreon ONTY, +11.41% a cancer-therapy company where activist investors just got board seats.
Selloffs in stocks like these are just par for the course in biotech, and they offer a great entry opportunity.
“Most people realize this is just a part of the cycle,” says Garren. “These are not broken companies. It is just a broken market for biotech right now.”
At the time of publication, Michael Brush owned shares of SGEN and ONTY. Over the past five years, Brush has suggested ONTY, SGEN, GILD, BIIB, AMGN, CELG and ANAC in his stock newsletter, Brush Up on Stocks. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist group, and he attended Columbia Business School in the Knight-Bagehot program.
This entry passed through the Full-Text RSS service – if this is your content and you’re reading it on someone else’s site, please read the FAQ at fivefilters.org/content-only/faq.php#publishers.