Is Biotech Still Attractive? Print
By Brian Wilson - Lead Contributor   
Tuesday, 15 October 2013 10:08
One important question to ask when choosing investments in one particular industry is whether or not that industry is still attractive to investors looking at the big picture. Last week, we saw just how important this is. Although the S&P 500 only saw a mild correction, the NASDAQ biotechnology index (NASDAQ: NBI) fell nearly ten percent last Tuesday and Wednesday. Even the larger biotech companies with well-established, commercialized drugs, saw extensive declines in a short timeframe.

Although the biotech sector has enjoyed outperformance this year (NBI is still up nearly 50% YTD), many would argue that the move was supported by the fundamentals of the sector. Most large biotechs catering to rare disease indications have seen growth in product sales. It was also shown by a number of companies releasing new orphan drugs that reimbursement rates for these types of drugs remains extremely high, which implies that the development of these kinds of drugs remains feasible.

This is vital for smaller biopharmaceutical companies that are looking to develop drugs for rare disease indications using experimental biotechnology, because the clinical development of a novel drug generally takes 8-10 years. During this period, these companies are unable to generate revenue and they must rely on investors and partnerships that generate milestone payments (if attainable).

Still, investors should note that the sector remains vulnerable in the event of a broader market selloff. While we think it is definitely premature to call this another biotech bubble, although the current valuations of most companies aren’t considered cheap.

Emphasis on large-cap

In a recent report on this sector by Deutsche Bank, the comparative performance of large and small biotechnology companies in periods of biotech outperformance was analyzed. The companies that had established pipelines were able to continue outperformance for quite some time, while investors fled smaller and less established companies. These smaller biotechs almost always hold more potential for long-term gains, although the risk of insolvency is a very strong deterrent in times of market panic.

The outperformance of larger biotechs also makes more sense when you consider their ability to generate growing cash flow in an inherently defensive industry (pharmaceuticals). While small biotechs target this same industry, they are generally labeled as high-risk investments, and are among the first to be sold off by large money managers.

A few suggestions offered by Deutsche Bank going into 2014 include:

 Biogen Idec (NASDAQ: BIIB)  - because of the expected growth of the ongoing launch for Tecfidera

Gilead Sciences (NASDAQ: GILD) – because of their potential to expand in HCV and cancer indications

Celgene (NASDAQ: CELG) – because of the potential for Abraxane in pancreatic cancer

Still, investors should not be urged to dump all small to mid-cap biotech equity. Last week’s correction has already brought down a number of companies, which are now at down-to-earth valuations. It is simply a matter of being more selective, and being more focused on value plays in the space. There is still a lot of money to be made.

 




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