Biotech stocks continue to slump and have taken a beating for over 12 months, but some promising data could lead to a rebound.
The cheap valuations of the sector right now could be good entry points for investors, experts said.
One catalyst coming up in the fall is the pending decision from the FDA for the clinical trial of an Alzheimer drug, Eisai’s (ESALY) lecanemab that is being jointly developed with Biogen (BIIB). The results of the trial are set to be announced in the fall to see if the drug can delay the progression of the disease in early-stage patients.
Biogen already had to jettison its plans to sell Aduhelm, another drug to treat Alzheimer, since Medicare chose earlier in 2022 not to pay for it.
A positive result would benefit not only millions of patients and their families caring for them, but also investors for Biogen and Eisai since Alzheimer drugs could net over $20 billion in sales from just the U.S. according to a July report from Morgan Stanley.
If lecanemab shows positive data for efficacy for early Alzheimer’s disease there could be a 40% upside in Biogen’s shares with a 12% downside if it proves otherwise, said Salveen Richter, a managing director at Goldman Sachs, in a Sept. 16 research report, who remains cautious on Biogen. After a 24% underperformance in the biotech company’s shares over the last three months, the “options market positioning has recently started to turn more bullish,” she wrote.
Promising trial results could be a “huge boost” for the industry since the federal government is the number one client, Thomas Hayes, chairman of Great Hill Capital in New York, told TheStreet.
“It’s a very expensive drug and individuals can't afford to buy it on their own,” he said. “It would be a huge benefit for the families of Alzheimer patients.”
Another beneficiary would be long-term care insurance companies such as Genworth (GNW), Hayes said.
Biotech Stocks Are Still Cheap
Biotechs are still trading at its lowest price/sales ratio in over a decade, but the long-term outlook remains positive for investors who have patience to wait for a rebound over the next two years, he said.
The last time the biotech market experienced a similar drawdown was during the 2015 to 2016 time period when the decline was 50%. In the following 23 months, biotech stocks found themselves back to new highs and the sector rose by over 130%, Hayes said.
The biotech slump began in February 2021 and has corrected over 50%, but a previous report from Bank of America said a rebound could range from 24% to 155%.
Biotech stocks are “casino-like investments that can strike it big or burn down,” Anthony Chan, former chief economist for JPMorgan Chase, told TheStreet. “In an environment where higher interest rates and higher inflation pose threats to the economy, investors will shy away from this sector.”
As fundamentals of the economy weaken, the performance of the biotech sector is exhibiting some resilience, he said. The lion’s share of the woes of the biotech sector is emanating from Fed rate hikes and the widening of credit spreads.
“Those factors serve as headwinds on the valuation front,” Chan said. “Biotechs rely on longer-term earnings and garner lower valuations with higher interest rates.”
Deals have also slowed down in the sector aside from Novo Nordisk (NVO) spending $1.1 billion to buy Forma Therapeutics to add blood disorders to its pipeline, Pfizer (PFE) shelling out $5.4 billion to acquire Global Blood Therapeutics for its treatment of sickle cell disease and Amgen (AMGN) buying ChemoCentryx to add autoimmune diseases, inflammatory disorders and cancer treatments to its portfolio for $4 billion.
The credit markets have tightened with the Fed’s hawkish stance of raising interest rates, he said.
“It seems like deal activity has started to slow because credit is more expensive,” Hayes said. “The risk appetite has changed given Fed Chairman Jerome Powell’s insistence on unnecessary pain. The cost of capital has gone up. People are more careful of what deals they do and how they pay for them since capital is no longer free.”
A change in the Fed’s current posture could entice investors to come back, but they should expect to wait a couple of years.
“It’s a three year bet and the slump began early in 2022,” Hayes said.
The best way to play this sector is through the SPDR S&P Biotech ETF (XBI), which is currently trading at $75.76, falling from its 52-week high of $134.79.
The top four holdings in the ETF are AbbVie (ABBV), Chemocentryx (CCXI), Biohaven Pharmaceutical (BHVN) and Global Blood Therapeutics (GBT).
Biotech stocks still remain cheap right now for investors who have a one to three year view, he said.
Biotechs Will Rebound
Hayes remains bullish on biotechs since the Fed will eventually start to ease up and M&A activity will return.
“Biotech has clear catalysts and demand is starting to come out of covid while the drug pricing legislation was not nearly as bad as the market feared,” he said. “The sector has been out of favor despite the bounce from the May lows and we could see more deals, consolidation and more drug approvals moving forward.”
When the Fed stops raising rates and the “clouds of uncertainty lift, investors will focus on the long-term positive potential of this sector,” Chan said.
“This is an opportune time to start planning for M&A due to favorable valuations in the sector,” he said. “We are at the point where valuations are attractive, but given that valuations of the acquirers have also dropped – we have a bit of a catch-22 situation. At this time, biotech companies may want to form partnerships that will strengthen their long-term profit potential and position themselves for some exciting M&A opportunities when the storm clouds dissipate.”
