Which one is cheaper, Biotech or Big Pharma?
After years of skyrocketing stock prices fueled by blockbuster drug sales, Big Biotech is now seen by investors as being no better, and perhaps worse, than Big Pharma.
The biotech skeptics are wrong.
Biotech stocks in the Standard & Poor’s 500 index, as a group, fetch a mere 13.2 times projected earnings for the next 12 months—well below the sector’s 16.3 five-year average and a 20% discount to pharmaceutical stocks. This has rarely occurred in the past decade.
To justify the current valuation, Big Biotech’s research pipeline would have to produce a string of flops, and the sector’s double-digit profit growth would have to slow precipitously.
“I prefer biotech to pharma right now because of the valuations. You are getting good pipeline assets at a much bigger discount,” says Marshall Gordon, manager of the ClearBridge Global Health Care Innovations fund. (For more on pharmaceutical stocks, see page 36.)
Granted, the SPDR S&P Biotech exchange-traded fund (ticker: XBI) and the iShares Nasdaq Biotechnology ETF (IBB) have rallied in recent months, partly due to speculation about takeovers and acquisitions. Still, biotech remains mired in bear-market territory, with both funds down around 24% since their July 2015 peaks. Investors are worried that the political furor over high drug prices will continue, undermining the values placed on pipelines.
Until last year, biotech had shined. Traditionally, these drug makers—which develop therapies derived from living cells, rather than combining chemical compounds—have profited from a flood of scientific breakthroughs. Over the past five years, biotech companies in the S&P 500 expanded sales at a compounded annual rate of almost 24%, while pharmaceutical sales, hobbled by older blockbuster drugs losing patent protections, fell 3.5%.
The result? When the Nasdaq Biotech index hit its peak last year, it had gained about 420% during the previous five years, besting the NYSE Arca Pharmaceutical index by more than 280 percentage points. This year, sales generated by the pharmaceutical companies in the S&P 500 could rise more than 5%, their biggest gain since 2011, while average revenue growth slows to 6.3% for biotech stocks in the index.
Still, industry fundamentals don’t justify a higher valuation for Big Pharma, argues Morgan Stanley analyst Matthew Harrison.
Why? To drive sales, biotechs rely on price hikes far less than pharmaceutical companies. And clinical trial results due this year and next year could reinvigorate confidence in biotech drug pipelines. Investors seem to have far less confidence in biotech pipelines than they do in pharmaceutical ones.
Big Biotech balance sheets are flush with cash, supporting the notion that the sector can buy growth. In fact, biotech companies could average earnings growth of 25% annually from 2017 to 2020, says Harrison.
Joe Dennison, portfolio manager at Zevenbergen Capital Investment, says it’s “a perfect time to do some bottom-up research and find companies that got lost in the shuffle.”
Alexion is a growth play, offering double-digit profit growth and an underappreciated pipeline.
Though down about 36% since hitting a peak in July 2015, shares of Alexion trade for about 25 times forward earnings, or almost twice Big Biotech’s multiple. However, the drug maker, which focuses on treatments for rare diseases, is expected to grow earnings by 27% next year.
Worries about the durability of Alexion’s main drug, Soliris, a treatment for two extremely rare blood conditions, have pressured the stock in the face of looming patent expirations. But some analysts see profits growing at a faster clip, as Alexion tries to expand Soliris’ use into new markets while also developing a next-generation version of the drug.
Moreover, Alexion is launching new drugs, among them, Strensiq, a treatment for an often deadly metabolic disorder, and Kanuma, which treats a deadly enzyme deficiency. Both were approved by the Federal Drug Administration last year.
By 2020, Alexion’s revenue could double to $6.9 billion, according to Morgan Stanley’s Harrison.
Amgen, by comparison, is older and to some a far stodgier name that more closely resembles a big pharmaceutical company, with a 2.3% dividend yield, aggressive cost-cutting efforts, and older drugs that face competition from lower-priced rivals.
But even after a 17% rally in the past three months, the stock trades at 15.2 times forward earnings, making it one of the cheapest biotechnology stocks in the S&P 500.
Analysts expect 9% annual profit growth over the next five years, hardly breathtaking. But cost-cutting is improving margins, and as Barrons.com noted last year, Amgen’s pipeline has several potential blockbusters. Meanwhile, analysts await results due next year from a large study testing whether its cholesterol-lowering drug Repatha helps prevent strokes and heart attacks. Good news would pump life into the drug’s sales.
Granted, many investors remain sidelined by concerns that political pressure could lead to an overhaul of drug pricing that ravages sales and profits. Both Hillary Clinton, the Democratic presidential candidate, and Republican candidate Donald Trump have vowed to address the issue if victorious in November.
However, investors who buy now enjoy a buffer in the form of low valuations. •
What Does Mighty Apple Want With Tiny McLaren?
if apple really wants to make a splash in the automotive world, buying McLaren Technology Group is a rather small step. But it’s typical Apple, and it’s probably a wise move.
Apple (ticker: AAPL), of course, could easily buy any major car maker, so why bother with Britain’s McLaren, which makes just 1,500 of its exotic supercars each year?
McLaren fits Apple’s strategy of buying small and thinking big. While Apple has roughly $230 billion of cash in the bank, it’s never made large purchases like so many of its free-spending peers. Its largest-ever purchase was the $3 billion it spent on Beats Electronics.
That’s a pittance in the corporate world, where some $2.4 trillion worth of deals has been announced this year.
In reporting Apple’s interest in McLaren, the Financial Times estimated the car maker was worth less than $2 billion. General Motors (GM), by comparison, would probably cost over $100 billion, if it were willing to sell, that is.
McLaren would bring some key automotive technology, but it’s still small enough to be reshaped as needed by Apple’s management team.
Source @ BARRONs