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Bargains abound in biotech.
But so do gnarly Covid-19 pitfalls that could sink your investments.
I’ll get to five biotechnology companies that dodge these issues in a second — two favorites from my stock newsletter, Brush Up on Stocks, and three from the biotech team at Jefferies.
But first, here are the three main Covid-19 landmines for biotech investors to watch out for, and how to diffuse them.
Landmine No. 1: Smaller biotech companies short on cash will face a funding crunch if the stock market stays down. They’ll be forced to dilute the heck out of shareholders by raising capital.
How to diffuse it: Favor biotech companies that just raised cash, or have enough on hand to cover at least 18 months of cash burn, says Jefferies biotech analyst Michael Yee.
Several companies were lucky enough to raise capital right before the biotech group started to fall apart on March 6. Among small biotech companies, Karyopharm Therapeutics KPTI, +7.90% was that last one to extract money from the stock market before the fall, on March 3, according to a Jefferies screen. Twist Bioscience TWST, +7.49% and BioXcel Therapeutics BTAI, +0.96% pulled off a similar feat by raising money in the last 10 days of February.
Any of the dozens of companies raising capital in January and February should be able to wait out the storm. Otherwise, favor companies that have a lot of cash relative to their cash burn. Two small biotech companies with very high cash levels relative to cash burn rates are Viking Therapeutics VKTX, +3.70% and Pieris Pharmaceuticals PIRS, +5.26%, according to a screen from Jefferies.
Landmine No. 2: Drug trials could be disrupted by “shelter in place” limits on travel, or a ban on elective procedures in hospitals.
How to diffuse it: Favor companies that are able to do assessments of patients via video conference or phone. Next, companies with cancer therapies should be safe here. Their patients will probably do all they can to avoid missing potentially lifesaving treatments.
Be more careful with companies running trials that require biopsies. They could see disruptions since biopsies may fall into the bucket of “elective procedures” that hospitals postpone to free up resources for Covid-19 victims. A Phase II study of liver ailment therapies by Akero Therapeutics AKRO, -0.75% may face hurdles. Finally, very small companies with only one trial in progress could also be more vulnerable if “shelter in place” drags out.
Fortunately, the Food and Drug Administration (FDA) has signaled it will be OK with reasonable changes to drug trial protocols, as long as they are documented. It’s also open to virtual meetings with companies to review data and discuss issues. “The FDA appears to be flexible and understanding,” says Yee.
Landmine No. 3: Drug companies’ sales forces are getting grounded.
How to diffuse it: This is one of those problems that I like to call a “one-off,” or fixable, issue. The cure for this kind of issue in investing is simple: Patience.
Otherwise, be a little more cautious with companies that were generating excitement because they were launching a new product. Covid-19 slowed the launch momentum of FibroGen’s FGEN, +11.00% anemia drug called roxadustat in China, for example. This could be an issue if it drags out.
“In-person visits to physicians and hospitals remain prohibited, which in our view could blunt the launch momentum,” William Blair biotech analyst Andy Hsieh wrote in a March 3 note. That’s one reason he has a “market perform” rating on the stock. Again, though, time will make this issue go away.
Some positives
One positive for biopharma companies is that recessions don’t hurt demand for medicine. Plus, valuations of early stage companies are all about what happens years from now when drugs come to market — long after Covid-19 will be just a memory.
This is probably why much of biotech has held up relatively well. It is one of the stronger S&P 500 SPX, +6.76% groups in this bear market. Biotech stocks in the S&P 500 are down only 5.8% this year compared with a 26% drop for the S&P 500.
The iShares NASDAQ Biotechnology Index IBB, +3.92% is down more, with a 16.5% decline from the start of the year. The SPDR S&P Biotech exchange traded fund XBI, +5.79% is down the most. It has fallen as much as the S&P 500. That’s because it contains a larger proportion of smaller, more volatile stocks.
Favorite biotech companies
Here’s a standing trick that Yee at Jefferies uses when biotech gets hammered. Favor large-cap stocks with decent sales and cash levels when their market caps fall close to the estimated value of their approved products.
This suggests you get their development pipelines of potential drugs “for free.” Indeed, a sentiment signal of a potential bottom in biotech stocks, for me, is when Yee runs his “biotech pipelines for free” research note.
Large-cap biotech stocks he likes right now trading close to their no-pipeline valuations are Amgen ( AMGN, +5.46%, Gilead Sciences GILD, +1.90% and Vertex VRTX, +7.34%. They recently traded just 15% or less above their no-pipeline valuations — the stock prices they’d have to hit so you’d be getting their pipelines for free. Their no-pipeline valuations are $155 a share for Amgen, $60 for Gilead and $190 for Vertex. Yee’s price targets on those stocks are $285, $89 and $275, respectively.
Yee notes large-cap biotech stocks like those recently traded at price-to-earnings multiples rarely seen in the past 20 years, including during the dark days of the financial crisis when biotech was also weighed down by the prospects of Obamacare. This valuation extreme also suggests they are buyable here.
Two names from my stock letter I like a lot in the current pullback are Kodiak Sciences KOD, +0.80% and Acadia Pharmaceuticals ACAD, +6.13%. They both rank high in the system I use for evaluating biotech companies, in part, because they have promising products in development, and technology platforms capable of spawning many products.
Kodiak has a proprietary antibody biopolymer conjugate tech platform producing promising therapies for retinal diseases. I first suggested this name in my letter at around $10 in October 2018, but the signal is still strong in my system here in the low-$40 range. Though strictly speaking, my current suggested buy limit is $40.
Acadia has a dug called pimavanserin used to treat psychosis in Parkinson’s disease patients. That application of the drug should bring in around $450 million this year, enough to cover overhead. The company looks safe on the cash-burn front. I liked this stock a lot in the $15 range in 2018 when it was under short-seller attack, and it currently trades well below my $42 suggested buy limit.
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested KPTI, PIRS, AMGN, GILD, KOD and ACAD 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.
