Some investors are waiting for a decline in the U.S. stock market to put new money to work.
They just got one — in biotech.
As of Nov. 14, biotech exchange traded funds (ETFs) like the iShares Nasdaq Biotechnology (IBB) and SPDR S&P Biotech (XBI) were down 11.5% intraday since early October. That exceeds the standard definition of a "correction" (10% decline), suggesting it might be time to get in.
More importantly, biotech experts see a buy signal in the emotional nature of the selloff on Nov. 14, the day the sector hit its recent lows. Many biotech stocks were down big that day — 5% or more — on huge volume, but little to no real news. Was this the "big puke" day that so often punctuates the low in selloffs?
"I think so," says Jared Holz, a health-care trading desk strategist at Jefferies. Big down days on high volume and little news are typically where bottoms occur, he says. Biotech sector experts like Holz cite four reasons why the sector has been weak. None of them suggest to me that the group is permanently impaired.
"All of this has to be viewed in the context of biotech being up almost 50% this year," says Brad Loncar, of Loncar Investments. Before the selling starting in early October, the SPDR S&P Biotech had advanced over 48% in 2017.
"What is going on doesn't worry me because it is a normal selloff after a good year. I see a lot of stocks that are reasonably priced and some that are outright cheap," says Loncar. I have six suggestions, below.
Dearth of acquisitions
Many investors started off the year with high hopes for a biotech buyout frenzy. So far, nada. Outside of Gilead's (GILD) purchase of Kite Pharma and a few smaller deals, not much has happened.
Why not? The excellent biotech stock performance this year took pressure off large companies to make purchases to move their stocks up. It also meant potential targets got more expensive.
"A lot of weak hands were playing biotech for takeouts," says Holz. Now they are throwing in the towel. Holz, however, thinks 2018 could bring big buyouts. After all, large pharmaceutical companies still need to build out their pipelines, and they have the cash to buy. Targets now look more attractive.
Tax reform delays
Many people bought biotech stocks earlier this year hoping that Washington, D.C., would pass tax reform that eases repatriation of cash. This was supposed to enrich big pharma and biotech, so that they could go on a buying spree.
So far, though, President Trump and his allies in Congress have disappointed investors, bigly.
"That clearly is working against us," says Jeff Jonas, a portfolio manager and biotech expert at Gabelli Funds. This is one reason he's not sure a bottom has been put in. "I don't think we're quite there yet."
High-profile biotech companies from Celgene (CELG) and Gilead, to Regeneron (REGN) and Intercept Pharmaceuticals (ICPT) have all reported weaker-than-expected sales or pipeline setbacks. The negativity has weighed on the space, while tech companies like Microsoft (MSFT), Intel (INTC) and Nvidia (NVDA) posted strong quarters.
"Tech was beating and biotech was not. So people may have been selling biotech to go into tech," says Haicheng Li, a biotech analyst and portfolio manager at Chautauqua Capital Management.
But this dichotomy won't last forever. "Very little has changed with regard to most biotech companies, and that is the opportunity," says Holz.
Besides the biotech ETFs iShares Nasdaq Biotechnology and SPDR S&P Biotech, here are six names to consider buying in the current weakness.
I've liked and owned Incyte (INCY) since I first suggested it in my stock newsletter, Brush Up on Stocks, at $14 in late 2011. It made a nice run up to $153 by last March. Since then it has pulled back sharply to $105. I think this is a great entry point. Incyte trades well below my most recent buy limit of $130.
Incyte has a profitable drug for rare blood diseases called Jakafi. It has a drug for rheumatoid arthritis, called Olumiant. Incyte also has a robust pipeline. The highlight is epacadostat, which may enhance the effectiveness of cancer therapies. Incyte is collaborating with Merck (MRK), Bristol-Myers Squibb (BMY), AstraZeneca (AZN) and Roche (RHHBY) to see how well its epacadostat improves their cancer drugs.
"They have a decent pipeline that is not recognized," says Li at Chautauqua Capital Management, which has an overweight position in this name.
This is a promising name for biotech investors who like profitable large cap names with pipeline potential. Vertex (VRTX) dominates cystic fibrosis treatment with its drugs Kalydeco and Orkambi. The company is broadening out its franchise here, with new therapies.
Health-care stocks for investors
It currently treats about half of cystic fibrosis patients, but it can probably bump that up to 80%, says Brian Skorney, a biotech analyst at Baird. He thinks that will help push annual revenue to $7 billion by the early 2020s, from around $2 billion now, producing double digit annual earnings growth along the way.
Sarepta Therapeutics (SRPT) offers a therapy for the rare muscle-wasting disease duchenne muscular dystrophy (DMD), called Exondys 51.
The drug should generate about $150 million in revenue this year, with much more to come. Sarepta is developing improved versions of this drug, as well as a gene therapy for DMD, says Baird's Skorney, who has a $101 price target on this company. I first suggested Sarepta in my stock newsletter at $16-$21 in late 2016, and I reiterated it Nov. 8-9 at $51-$52. The stock recently sold for $56.
Ligand (LGND) looks like a relatively "safe" biotech name because it has such a broad array of biotech know-how and potential therapies that it licenses in exchange for royalties. "So any one failure doesn't impact them that greatly," says Jonas, at Gabelli.
Ligand has a hand in over 160 different drug-development programs at over 95 pharmaceutical and biotech companies, including Bristol-Myers Squibb, Eli Lilly (LLY), Pfizer (PFE) and Sage Therapeutics (SAGE) Sage is probably about to get approval for a post-partum depression drug called brexanolone, on which Ligand will collect royalties.
Shares of this Dublin-based drug company have sold off sharply in large part because of concerns about threats to its hemophilia drugs from gene therapy treatments in development. "But gene therapy is very expensive. And it is still several years off," says Jonas.
Shire's (SHPG) stock looks cheap trading at just 10 times earnings, despite its promising pipeline. Next year, for example, Shire should launch a drug for hereditary angioedema, called lanadelumab. It is also developing its own potential gene therapies for hemophilia.
Alexion (ALXN) offers a drug called Soliris for extremely rare afflictions like shortness of breath during sleep and a disorder that damages vital organs. Alexion is expanding the use Soliris to treat other ailments. It has two other drugs for rare diseases called Strensiq and Kanuma plus several drugs in development. The company has a strong balance sheet, which it might use to build its product line via acquisitions, says Jonas.
If you buy any of these companies, be warned: Biotech is notoriously volatile. That's great on the upside, but it can be painful during declines. Don't get involved unless you truly have a multi-year time horizon.
At the time of publication, Michael Brush owned INCY and SRPT. Brush has suggested INCY, SRPT and ALXN in his stock newsletter, Brush Up on Stocks. Brush is a Manhattan-based financial writer who has covered business for the New York Times and The Economist group, and he attended Columbia Business School in the Knight-Bagehot program.
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