Whatever you think of Massachusetts Sen. Elizabeth Warren, you owe the 2020 Democratic presidential candidate thanks as an investor. Warren has created a nice buying opportunity in biotech.
The steep decline in biotech stocks since mid September is almost the mirror image of her sharp rise in the polls — and for good reason. Warren is among those calling for dramatic government surgery on the health-care industry, which would almost certainly cut out most of the pricing power enjoyed by biotech companies.
Since September 16, Warren has risen 57% in election polls, according to Real Clear Politics. During that time, the iShares Nasdaq Biotechnology Index IBB, +1.28% and SPDR S&P XBI, +1.78% exchange-traded funds have lost 6% and 10%, respectively, compared to a 2% decline in the S&P 500 SPX, +0.64% .
The shares of many individual biotech companies have fallen even more sharply. Many biotech stocks are now so cheap, investors get entire drug research pipelines at a nice discount and even for free (or better) because market capitalizations are below cash levels, according to calculations by Jefferies Financial Group JEF, +0.86% biotech sector analyst Michael Yee. Large cap biotech stocks trade for a price earnings ratio of around 10, deep inside the historic range of 7.0-14, he points out.
There’s a chance that investors are overly worried about Warren.
Of course, the Warren risk for biotech is real. But by now, it is so widely known it’s probably fully priced in. And there’s a chance that investors are overly worried about Warren. She’s likely to move more towards the political center if she gets the Democratic nomination, Yee predicts.
Plus, Warren faces an obstacle in her health-care reform crusade. True, many Republicans including President Donald Trump are aligned with Democrats on the perceived need to control drug pricing, despite the negative impact this would have on drug discovery. But it’s tough to imagine the left and the right cooperating on much of anything in this divisive political environment.
Problems beyond Warren
There are at least two other risks discounting biotech. But, again, both may not be such a big problem. One hurdle is the Federal Trade Commission, which nowadays seems to have a greater propensity to put biotech mergers under the microscope, says Brad Loncar of the Loncar China BioPharma ETF CHNA, +1.37% . Most recently, the FTC has been digging deep into the proposed Roche RHHBY, -0.33% buyout of Spark Therapeutics ONCE, -1.80% , and a merger of AbbVie ABBV, +0.00% and Allergan AGN, +0.65% .
Many analysts, including Loncar, wonder whether this is a sign that the FTC is taking a closer look at biotech mergers because of pressure to help control drug prices. We don’t have any proof that’s their motive, though. And personally, I’d be surprised if the Trump administration turned so anti-business that it began to habitually block mergers.
Then there are the recession worries. When stock markets sell off because of a recession, high-beta biotech names often fall even more than market indices like the Dow Jones Industrial Average DJIA, +0.57% or Nasdaq COMP, +0.60% . But while recession fears are now consensus, I think worries about a recession near term are misplaced, as I have written here and here
Biotech catalysts ahead
Because of the sector weakness caused by these overhangs, Yee, the Jeffries analyst, has turned more bullish on biotech — at least for the near term. “There is going to be a short term bounce, because biotech has sold off so much,” he said in an interview this week. He cites at least three potential catalysts:
2. More mergers and acquisitions: These tend to pick up when biotech stocks decline as they have recently. They can also pick up around the turn of the year.
3. Woodstock for biotech nerds: Jefferies competitor JP Morgan Chase JPM, +1.40% holds a big biotech conference each January at which companies show off their science and release updates. This can spark investor interest in the group.
Beyond the trading call, I think the current discounts on biotech stocks present a decent entry for medium term, one-to-three year positions. Yee is more cautious. “We do believe there could be a short term bounce, but we are not out of the tunnel,” he says, citing concerns about the FTC, recession and political risks.
What to buy in biotech
Here’s a quick guide to some stocks if you want to take advantage of the Warren discount. These are companies Yee cites in an October 4 report to clients. It singles out biotech companies that have sold off so much you can get their research pipelines at an unusually steep discount — or better yet, for free.
1. Gilead Sciences
At $63 a share, Gilead Sciences GILD, +2.07% trades below the $65 valuation that Yee has for the business without the pipeline. Buy the stock now, and you get the pipeline for free. That pipeline contains potentially promising therapies for the liver disease nonalcoholic steatohepatitis (NASH), and another drug candidate called filgotinib for rheumatoid arthritis, Crohn’s disease and colitis, among many others. Gilead pays a 4% dividend yield.
2. Vertex Pharmaceuticals
At $170 a share, Vertex Pharmaceuticals VRTX, +0.88% trades below the no pipeline value of $185 that Jefferies analyst Andrew Tsai assigns the stock. Yet that pipeline contains a potential gene editing therapy for sickle cell disease, a possible treatment for a rare genetic disorder called causing alpha-1 antitrypsin deficiency which can damage the lungs and liver, and promising therapies for pain management, among others.
At $199 a share, Amgen AMGN, +1.01% trades close to the $165 per share value Yee assigns to the company sans pipeline, which includes a promising cancer therapies code named AMG 510 and AMG 701, and another for severe asthma called tezepelumab, among many others. Amgen offers a 3% yield.
At $223 a share, Biogen BIIB, +0.39% trades near Yee’s $190 no-pipeline valuation. The company’s pipeline includes a promising therapy for Parkinson’s disease called BIIB054, another for progressive supranuclear palsy called BIIB092, and several potential therapies for Lou Gehrig’s disease and lupus, among others.
Deep discount small-caps
Small biotech companies can be inherently risky because they have no products on the market, and they are burning through cash to reach that goal. But when they trade near or below net cash levels , that reduces the risk.
Not only are you getting the research efforts “for free,” but there’s some insurance against dilution from capital raises, at least near term. It helps to focus on those with cash in the bank that is significantly above cash burn rates.
In my stock letter I also insist on collaborations with big pharma companies at smaller names like these — as an outside affirmation of their pipeline potential.
One company with more than six quarters’ worth of cash at its current burn rate, according to Yee, is Prothena PRTA, -0.53% , which develops therapies for neurological disorders such as Parkinson’s disease (in collaboration with Roche ROG, +0.59% ), Alzheimer’s disease, and Lou Gehrig’s Disease. The company is super cash-rich. Cash levels exceed enterprise value (debt plus market cap) by $65 million.
Here are two companies with market caps a bit above cash levels — which means you get the pipelines almost for free. Each currently has cash to cover the next three quarters at their most recently quarterly cash burn rate.
• CytomX Therapeutics CTMX, +3.57% is working on a therapy that helps cancer drugs better target tumors, to reduce collateral damage. It has partnerships with AbbVie, Amgen, and Bristol-Myers Squibb BMY, -0.10%
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested IBB, XBI, CHNA, ONCE, ABBV, AGN, GILD, AMGN, BIIB and GLYC in his stock newsletter , Brush Up on Stocks.