2009 Biopharmaceutical Portfolio

2009 Biopharmaceutical Portfolio

Steady as she goes.

Rod Raynovich Final for GEN 2/2/2009

Despite one of the worst years for investors since the Depression with market indices down 40%, biotech stocks provided a safe haven from the leveraged credit cowboys in 2008 with major bio ETF’s down only about 10%. My balanced biotech portfolio with 75% in large caps and ETF’s was up 3-9% in 2008 depending upon weighting of mid cap winners such as CBST, MYGN and VPHM. (If you want to look back to more difficult times look at 2002 and the early 90’s.) As a result of the global meltdown and avoidance of risk, hedge funds, mutual funds and speculative investors sold biotech and pharma stocks in Q4 to raise cash. Many highflying biotech stocks did worse as the hedge funds that created the momentum were forced to take profits as their leverage was cut back.

At the recent Rodman and Renshaw Investment Conference in November the buzzword was “cash runway” as smaller cap companies with weak balance sheets need to retrench until new money comes back into the market. Nonetheless Rodman continues to fund PIPES in the biotechnology sector as technology is progressing and deals are being done.

Negative articles and “hand wringing” abound in the biotech market citing clinical trial failures, political concerns, a dearth of funding and a “breakdown of the business model”. But these critics miss the point that the universe of companies and universities in the biomedical sector are trading and investing in R&D programs that result in drugs, diagnostics and services with the objective of improving healthcare. Yes R&D may be becoming less efficient with fewer drug approvals (only 18 in 2008) and costs are increasing but the market will always be there because of growing demand from consumers and the core engine -NIH and university research. Healthcare spending grew at 6% in 2007 for a total of $2.2 Trillion and that is the available market for innovation with improved products and services that cut costs or improve quality of life. And the core driver is the “food chain” effect where licensing and acquisitions make the market until capital markets revive.

We are still in a bear market for biotechnology due to lack of speculative funding from both VC’s and investment banks syndicating IPO’s. As a result we have a more bifurcated market with larger caps stable or growing and smaller caps in a funk. There are no megathemes like genomics or lifestyle drugs that can spur momentum. Nonetheless there is plenty of money on the sidelines that will drive stocks of companies with compelling products and technology.

Politics as Usual

In my recent “Point of View” article in the Jan. 1, 2009 GEN I commented on the political backdrop for healthcare. Follow on Biologics (FOB) is coming but it is a longer term issue for selected companies and may be an investment opportunity for niche companies focused in this area partnered with larger pharmaceutical companies. National health care will be a focus and expect any proposals to try to find money in the 20% share of the insurance companies’ take. The DEMS are likely to be tougher on blockbuster drug pricing and big pharma because that is where the government spending looms large. The Medicare Drug benefit costs $47.6B in 2007. Overall the political environment should favor biotech as the NIH $28B research budget should be expanded with new champions (Eric Lander and Harold Varmus) and stem cell research controls are lessened.

Outlook for 2009-Cautious but Favorable

Despite the current gloom and doom the forecast for 2009 looks good especially toward Q4 when smaller caps recover due to the usual drivers: M&A, product news and research breakthroughs. Keep in mind that the bear market is still intact. As I forecasted last year biotech and healthcare will outperform other market sectors as it is less dependent on the general economy and credit. A 10% return should be achievable with a diversified portfolio with a weighting toward large caps and mid caps with strong balance sheets. Balance out the portfolio with niche themes by adding positions in generics, diagnostics, IT and tools. Politics will not have a negative impact and in fact should be favorable for life science research. Some overhang is expected from the credit crunch but there is plenty of money on the sidelines and little else to do with it. My investing model as in previous years is to have a balanced portfolio but to be opportunistic with speculative small caps when momentum returns. Small and mid caps were more beaten up than large caps so well funded companies should make a comeback. I have also added more diversification outside biopharma with tools and Dx than in previous years to reflect their increasing importance in drug discovery and targeting therapy.

Allocation of funds

60% in large cap biotechs and ETF’s:

If there is market strength in biotech the top tier will do well. Moreover there is less risk as biotech is deemed a defensive growth replacing large cap pharma which is languishing due to slower sales growth, a generic threat for blockbusters and ongoing FED litigation due to improper marketing practices.
25% in XBI, 10% in IBB, 25% in AMGN, BIIB, CEPH, DNA, GILD

25% in Mid Caps:

AUXL CBST ISIS REGN SGEN UTHR VPHM

10% in Devices, Diagnostics and Tools

Pick four out of these six at attractive valuations:

  • ABAX –Abaxis-$100M+ Dx Co. in human and veterinary IVD’s; good balance sheet
  • CRA- Celera-morphed into “personalized disease management”-stock is stalled
  • GPRO-GenProbe-$500M+leader in nucleic acid tests for infectious disease
  • HOLX- Hologic-beaten up high -flyer due for recovery in 2009; diverse product line ILMN-Illumina-premier SNP array player in buying range
  • IMA –Inverness-beaten up $1.7B diagnostic trading at 1X sales

5% or more in speculative value

(10% for aggressive position taken out of Mid Caps)

Small cap companies need to conserve cash, watch headcount and “beef up” business development in order to create partnerships. Look for capitulation Q4 selling leaving good value for 2009. Ideas that offer value and clinical programs:
ARRY MITI RDEA RIGL SUPG TRGT

Niche plays:

The following mini-themes with large markets merit further research.

  • ABMD VOLC- small cap cardiovascular device plays
  • MNTA and TEVA-generic drugs
  • Athena health (ATHN) and Cerner (CERN)-Healthcare IT
  • Neogen (NEOG) for food and animal safety
  • Osiris Therapeutics (OSIR)-stem cells

Stocks to avoid

Look for these flags: less than 15 mos. of cash, broken down charts with no January recovery, stock price under a dollar. Also look at retained earnings to see how much investment was made in the Company since inception compared to current enterprise value.

Market Dynamics

Other than the large caps the market is currently skewed toward traders so investors should be aware of seasonality and volatility that masks long term trends. Despite other opinions my experience is that Q1 is not the best time to add new positions but Q3 is a better window because you can position yourself for a stronger Q4. Moreover an early Q1 rally can be over by Feb 15.

The retail trade, sell side and investment banks are not major participants as in previous years so hedge funds and institutional investors are the significant drivers of stock performance.

Lately pundits on financial news channels have been offering positive commentary on the biotech sector but that can be a contrarian indicator.

Detailed research reports on the healthcare industry and specific opinions on biotechnology companies are available from emerging players such Leerink Swann and Rodman & Renshaw.