Biotechnology Sector Q2 2013- At All Time Highs 

The BTK and ETFs such as the IBB and XBI hit all time highs on April 2. Of course the current  ramp cannot go on forever because money moves on, speculation ebbs and math intervenes.  We have been picking biotech stocks and forecasting this bull market since March 2009; the last major sell-off occurred during macro scares like August 2011 some 900 points ago on the NASDAQ. Since 2012 the biotech ETF IBB has decoupled from NASDAQ and has outperformed it by 80% and is up 18% YTD!  In Sep. 2012 we wrote that biotech was a relatively unknown sector but now the financial TV and Internet media has caught the buzz. The last significant correction was November 2012, about 20% lower than current prices depending on the index or ETF (XBI) you follow.We have written ad nauseum as to why biotech stocks are so hot so let’s review a few underlying factors:

  • Hedge funds that invest in biotech are flush with cash due to low interest rates and the FED.Hedgies are aggressive players that have huge leverage with a limited supply of quality life science stocks.
  • The supply of high quality public biotech companies is limited because of a 10 year slowdown in venture capital and weak IPO funding.Biotech companies need an extensive product pipeline and cash for long term R&D funding.
  • Retail investors are getting into the play as their financial advisors put them into biotech funds like the Five Star Fidelity Select Biotech (FBIOX) up 19.5% YTD. This pushes up the large cap biotech stocks even more. Same for popular ETFs: FBT, IBB,XBI
  • Metrics and valuations do not matter in biotech if the sentiment is bullish. If a hot biotech stock with no revenues has a $2B valuation, smaller cap stocks will follow seeking performance on a relative basis trending toward $1B market cap. Moreover momentum investors love trading volatile biotech stocks.
  • Biopharmaceutical stocks are not leveraged to GDP nor economic data. But macro concerns can certainly temper speculation.
  • Large cap drug stocks are hot due to their defensive nature, CAGR of 7% and dividends averaging 4%. The demand for defensive drug stocks has trickled down to mid and large cap biopharmaceutical stocks because they are growth stocks with M&A potential.Big pharma companies have $20-30B of cash for deals with biotech companies for pipeline and future product revenue.
  • Financial media is abuzz with biotech. It is no longer an esoteric market. Watch “CNBC and Cramer” or “Bloomberg TV” and you will hear the pumping. Amgen (AMGN), Biogen Idec (BIIB), Celgene (CELG) and Gilead (GILD) are now well known to retail investors.

One can argue that we are far from a “bubble market” such as the “Nifty Fifty” of the 60’s or the Internet and Biotech of the 90’s because the valuations of top tier biotech stocks are not excessive, although a Price to Sales ratio of 8-14  for many large cap biotechs may be deemed expensive to value investors.

Company              Ticker                 Revenues Est ’13          Forward PE         Stockholder Equity

Amgen                    AMGN                $18B                                 12.9                       $19B

Biogen Idec           BIIB                     $6.4B                               20.6                       $6.9B

Celgene                  CELG                   $6.11B                              17.3                        $5.7B

Gilead                     GILD                    $10.73B                           16.8                       $9.3B

Regeneron             REGN                  $1.9B                                32                          $1.3B

It is not just about the massive liquidity and positive sentiment. The industry is much more mature than it was during the last biotech bubble in 1999-2000 which was surpassed in 2011. Biotechnology has evolved technology platforms that create  products    faster for treating cancer, inflammation, multiple sclerosis and  infectious diseases.  Important treatment breakthroughs in genomics, targeted therapy, personalized medicine, immunotherapy and stem cells have created whole new categories of products.

So what can derail the momentum of biotech stocks? Financial contagion for sure. Much of the underlying strength is coupled to the overall market driven by the FED and the current demand for healthcare stocks. Even ObamaCare is deemed bullish for drug stocks because of  new patients. Some issues that can arise to trigger profit taking and overall weakness:

  • Global patent and protectionist issues such as the decision by India’s Supreme Court  to reject a Novartis drug patent. Premium pricing could erode.
  • Niche drug positioning strategies such as $100k++ doses of orphan drugs can be squeezed by cuts in reimbursement.
  • Generic (biosimilars) drugs are coming on the market for more mature biopharmaceuticals but the Regulatory and development  process will be slow.
  • Technicals combined with excessive valuations may spark a sell-off. A few crashes in emerging multi-$billion market cap stocks could slow momentum buying.
  • Reimbursement issues arise from Medicare, Medicaid and major insurance companies which temper pricing models. Many cancer drugs cost over $100k per year.
  • A few drug failures would focus on huge valuations of Phase 2 pipelines in mid-cap multi$B stocks.
  • Zero interest money fuels biotech like everything else so look for a bond market rally  (10 yr. TSY 1.82) to shift money flows.

Large cap biotech stocks can get very expensive before they are labeled such. Forward PEs are still in the 20s and 30s not considered expensive for growth stocks with a long product life cycle and strong cash flow. As investors reap big returns from the current bull cycle winners, comparable analysis will cause them to buy mid cap stocks that are relatively underowned. However speculation and momentum are major features of this market so the risk of a 5-10 % correction is already there. We have not yet  seen any trends or data which challenge this secular bull. Our model for stock picking has worked over four years and utilizes technicals, science and technology trends, stock ownership data and management experience. So stay tuned to see if the bull continues to roar.


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