Biotechs Set to Score Gains

kalina
16 Aug, 2003
New York City

As the market is on track to enter its strongest period, the biotech sector seems to be in good shape to post a better performance, despite the traditional volatility of biotech stocks. Find out which sector stocks offer real value.

Biotech companies stand at the cutting edge of science. The question of interest, however, is whether they make good investments at the present moment. The truth is that biotechnology stocks - although being notoriously volatile, - currently boast of a number of unique advantages working in their favor, that are also likely to make the biotechnology industry extremely attractive both in the near future and over the next decade.

Typically, the fall season is the strongest period for biotech stocks and hence it is not surprising that this coming autumn the biotech sector seems all set for a rally despite the ongoing gloomy economic and market conditions.

The sector as a whole has always had a solid downside support in the fact that people would always need medicines regardless of such factors as economic recession or an ongoing downtrend. This means sustained revenue streams for established biotech companies with marketable products. With the group of aging baby-boomers becoming increasingly dependent on medication, the sector's outlook seems bright due to that favorable demographic trend, not only in the United States, but also globally.

Another important catalyst is the expected spate of market-moving meetings, conferences and investor forums in the fourth quarter that are likely to drive sector stocks much higher than their current fairly stable levels. Historically, the annual biotech market cycle starts on a weak note in the wake of the JP Morgan Healthcare Conference in January. In late spring, the sector tends to recover, then turns slow in the summer, and finally gets a boost in August.

Furthermore, since January 2, 2003, the American Stock Exchange (AMEX) Biotechnology Index (BTK) has surged 26% - rising from 348.5 points to 439.1 points on August 12. The BTK index has outperformed the Nasdaq by more than 4% in the same period. If the ascent persists, as many market mavens now believe, this year's performance of the biotech index will buck the negative trend observed in two consecutive years - the widely followed index, which reflects the performance of 17 biotech concerns, had ended 2001 with a decline of 7.9% and slumped another 40.79% during 2002.

The upswing could be attributed to some extent to Dr. Mark McClellan, the chief commissionaire of the U.S. Food and Drug Administration (FDA), whose efforts made the regulatory process a more accommodating one. In the recent past, the primary concerns associated with the FDA were shortage of funds and weak leadership - and consequently a prolonged period for products' review. According to investment bank {{Burrill & Co.}}, product approval times slowed from median 12 months in 2000 to median 15.3 months in 2002.

Although this statistic was somewhat dismal, matters seem to be improving. Many analysts now assume that the FDA has managed to instill consistency in its procedures and speeded up the drug approval process, especially for products targeting life-threatening diseases. For instance, the recent approvals of Millennium Pharmaceuticals Inc.'s ((MLNM)) anticancer product {{Velcade}} and AstraZeneca PLC's ((AZN)) {{Iressa}} drug for lung cancer patients came as a pleasant surprise to many analysts. To be sure, an efficient and faster regulatory process will grant a better success rate and thus contribute further to the welfare of the sector. As a matter of fact, {{Burrill &Co.}} found that the biotech industry boasts 350 compounds under development or awaiting regulatory approval.

Biotechs Enter the VC Mainstream

Furthermore, there is evidence that cash is being reinfused into biotech companies lately. Labeled as far too risky to qualify for bank loans or high-yield securities, biotechs generally seek funds from more adventurous venture capitalists. According to the PricewaterhouseCoopers/VentureEconomics/National Venture Capital Allocation {{Money Tree Survey}}, the biotechnology industry accounted for 14.94% of all venture capital (VC) investing in the second quarter of 2003 - second only to the software industry, which grabbed 20.19% of all VC investment.

Data revealed that 66 biotechnology companies raised $639 million from VC investors in the second quarter of 2003. This is a rise of 13.5% over the preceding quarter, when 52 companies in the sector received $563 million. Still, the figure pales in comparison to the money that poured into coffers in the comparable quarter of 2002 when 87 biotech companies raised funds totaling $1.02 billion.

It is worth noting that venture capitalists putting money into biotechnology are aware of the stark reality that investments in the sector are high-risk and do not offer quick buck. Just the opposite - returns can be reaped only over a longer period of time, considering that it typically takes from five to ten years and a lot money before a biotech venture brings a viable product to the market.

Wisely Placing Bets

Added together, all circumstances confirm that patience and sound business fundamentals will sustain the biotechnology industry in the short and long haul. Data provided by the 10-year-old Biotechnology Industry Organization, the sector’s main trade group, indicates that over the past six years the market capitalization (the total value of publicly traded biotech companies at market prices) has grown from $93 billion in 1998 to $206 billion as of mid-April 2003, or a surge of 121.51%. Industry statistics shows that the number of companies has risen to 329 public biotech firms at the end of 2002. With few exceptions, biotech companies carry relatively modest stock-market values, which make them good entry points for forward-looking investors.

Still, piercing through scientific complexities to pick the essential from the hype, while selecting biotech stocks, is quite a difficult task. Investors should therefore look for companies that have already attained profitability, or, at least, those companies that are likely to prove successful in the near term. Other prerequisites for defining a biotechnology stock as a worthy bet include, - a healthy balance sheet; smart spending on Research and Development (R&D); promising products in late stages of development and ownership of the rights to these products, as well as solid market potential.

In this context, the industry's best performers (on 2002 product sales) include: Amgen Inc. ((AMGN)), Genentech Inc. ((DNA)), Serono SA ((SRA)), Biogen Inc. ((BGEN)), Genzyme Corp. ((GENZ)), MedImmune Inc. ((MEDI)), Chiron Corp. ((CHIR)), Gilead Sciences Inc. ((GILD)), Millennium and Intermune Inc. ((ITMN)). All of them have products that are available on pharmacy shelves, although Millennium and Intermune have not yet attained profitability. The four companies at the top of the list shot up more than $1 billion in annual sales. In the latest quarter, most of these companies continued to improve sales, giving investors reasons to cheer and justifying their statuses of top ten picks in the 25-year-old industry.

Gilead Made it Again

As regards second-quarter earnings results, the last day of July brought to center stage Foster City, Calif.-based Gilead Sciences, which was one of the very best performers last quarter - and indeed last year. The biopharmaceutical company delivered a fivefold rise in net earnings and a doubling of revenue.

Gilead, now the world's No. 4 biotech company measured by market capitalization, notched its fifth consecutive profitable quarter thanks to surging sales of its anti-HIV treatment {{Viread}}. The company reported second-quarter net income of $100.4 million, or 46 cents a share, compared to $19.7 million, or 10 cents a share in the year-ago quarter.

Total revenue soared to $238.9 million from $109.4 million in the prior-year quarter. {{Viread}} sales exploded 273.6% to $167 million versus $44.7 million in the same period last year. The company has raised 2003 sales guidance for {{Viread}} to a range between $550 million and $600 million from its previous estimate of $475 million to $500 million.

Gilead's other leading drugs include the anti-fungal agent {{AmBisome}} and {{Hepsera}}, a recently approved treatment for hepatitis B. {{AmBisome}} reached second-quarter sales of $51.2 million, up 7% from the year-ago period. {{Hepsera}} sales totaled $12.4 million, up from nearly $5.8 million in the first quarter.

Although the stock's latest price of $62.09 seems overvalued, savvy investors would admit that there are reasons to pour money in Gilead after considering the historical valuations of the stock. For the past five years, Gilead's Price-to-Sales (P/S) ratio - market capitalization divided by total revenue - has ranged between 6 and 22, while its Price-to-Earnings (P/E) ratio has fluctuated between 23 and 67. Projected sales this year are estimated to amount $800 million and earnings are seen coming at $1.65 a share, which means that the forward P/S ratio would be about 17 and the forward P/E would stand at about 41. Consequently, investors still have plenty of opportunities to seize the right moment and profit from Gilead, as these forward numbers are not beyond Gilead's historical valuations.

The company is also set to benefit from its recently approved anti-HIV drug {{Emtriva}} - its second antiretroviral agent. Moreover, Gilead is developing a fixed-dose formulation combining {{Viread}} and {{Emtriva}}, which, could potentially be available by early 2005. On final count, Gilead is one of the few biotech companies that are relatively quick in ramping up sales and earnings.

It is therefore evident that there are biotech bets that are fundamentally attractive offering high reward potential. So, one would be wise to dig into such companies' financials, choose judiciously and gain exposure to the sector. Investors wanting to capitalize on the potential financial rewards associated with the biotech sector should stick to well-managed companies that are poised to develop viable products and utilize safe technologies to yield new drugs.