The diagnostics and tools sector remain weak trading down about 1.9%  slightly better than NASDAQ down 2.5%. Within the life sciences we prefer biopharmaceutical stocks because of M&A potential and less sensitivity to earnings.

From October 11,2011

Despite a nice rally yesterday we are still cautious on the tools and diagnostics sector. Within the Life Science universe we favor mid and large cap biopharmaceuticals to play any fourth quarter rally. Illumina (ILMN $26) has still not found a bottom after revising its 3rd quarter revenue forecast last Thursday evening and withdrawing guidance going forward. The Company announced that its revenue for Q3 would be about $235M far short of analysts estimates of $280M. Assuming a market cap of $3.25B and 2011 revenues in the $1B range the stock is trading at a P/S of 3 and a PE in the 20’s. The stock is now trading at Dec.2009 levels so buyers should look for a technical bottom in the mid to low 20’s. The balance sheet is strong with over $1B of cash and investments and shareholder equity over $1B.

Since there could be Q3 earnings surprises from other companies it is better to be cautious. Large cap tools and diagnostics stocks that  have come back from Friday’s downdraft are: Agilent (A $33.93), Danaher(DHR $44.15) and ThermoFisher (TMO $53.76). Life Technologies (LIFE $37.08) stock has not recovered from Fridayas its products and markets overlap with Illumina.

Pure play diagnostic companies in our universe that are holding up through the summer correction are: Abaxis (ABAX $23.62), Exact Sciences(EXAS $7.88), GenProbe (GPRO $58.71), Neogen(NEOG $35.20) and Quidel (QDEL $16.48). Refer to our Q2 review of fundamentals of selected companies.

The Biopharmaceuticals sector is less correlated to the overall market and has better M&A drivers as larger drug companies are still seeking a broader pipeline. Moreover there is the upside potential of good clinical trials news. The balance sheet of mid-caps is important as the funding climate is sketchy. With the recent rally the NASDAQ-100(QQQ) has outperformed biotech by almost 5%. The QQQ has several large cap biopharma companies so you still get a play with the ETF. The XBI outperformed the IBB because there are fewer small cap  biotechs and tools companies within the XBI.

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