The Top 3 Biotech Stocks for 2017
This article was originally published on this site
2016 was a period of heavy consolidation for biotech stocks. The market spent much of the year finding solid ground, after an incredibly rocky showing in January and a disastrous end to 2015.
For context, in late 2015, the biotech sector took a major political hit.
In an extraordinary event, presidential candidate Hillary Clinton sent the $IBB (iShares NASDAQ Biotech Index) plummeting with a single tweet on social media site Twitter. Specifically, Hillary criticized price gouging in the pharmaceutical market and vowed to enact policies to prevent biotechs from “profiteering.”
In her public display, Hillary linked to a New York Times story with the headline: “Drug Goes From $13.50 a Tablet to $750, Overnight.” Many people were quickly outraged, and investors soon panicked at the thought of external pricing pressure from the public.
The results were near disastrous for anyone who was holding biotech stocks at their peak, as the sector proceeded to collapse nearly 20% over the next few months.
But for biotech investors sitting on the sidelines, this was actually a good thing… It meant that a new buying opportunity had suddenly emerged… And as the dust settled, fears surrounding regulation largely subsided.
From February 2016 through the back end of the year, the $IBB began an upward march once again, climbing over 7% in less than a year. The question now, of course, is whether or not this momentum will be a flash in the pan, or turn into a full-on bull market in 2017…
House of Cards
One of the first things pundits will point to when talking about a “biotech bubble” is price to earnings (P/E). That is, how much are we paying in relation to what these firms are actually pulling in on the bottom line?
If we look at the biotech sector in comparison to the remaining market, the answer might surprise you at first. For every dollar earned in biotech, investors are spending, on average, $17. Compared to broader market indices, that’s actually not very expensive right now. However, this is only true if you exclude gross outliers and companies with negative margins.
The reality is, of the 325 biotechnology companies listed on the market right now (major drug manufacturers included), only about 50 are turning a profit. Despite record industry highs over the past half-decade, the vast majority of public biotech firms are actually market laggards.
The reason for this disparity in performance is that the biotech sector is being propped up by a select few heavily weighted players. Small, development-stage companies have little to no impact on major indices, so it can be difficult to tell what’s going on under the surface just by looking at ETF performance.
If you peek behind the curtain, you’ll find that in 2016, ~60% of biotech stocks traded at a loss. In other words, you can’t simply pick a company in this sector at random and hope to come out a winner — even at a time when the broad sector is trading up 250% over the last half decade.
Playing Biotech in 2017
With biotech performance coming off record levels, it’s certainly a safe play to take any gains off the table if you began investing five years ago.
Then again, the same could be said for the stock market in general right now.
The truth is, biotech is only as risky as you make it. If you want to gamble, there will be a number of binary events to play this year.
If you want to speculate, there’s still plenty of room for the sector to run up — especially in regards to small caps.
But if you want to invest, know that the best biotech stocks of 2017 will have two things in common: value and diversification.
With a major sell off still in recent memory, investors are cutting their risk and falling back on companies actually generating money. When bubbles pop, stocks with the highest multiples (or no earnings at all) tend to come crashing down the hardest. For this reason, the best biotech plays in 2017 are going to be those with strong value metrics and diversified revenue streams.
In such a bloated market, value in biotech isn’t particularly easy to find, which is why we’ve decided to help out and share our top three picks for the year.
Gilead (NASDAQ: GILD)
Over the last five years, Gilead Sciences (NASDAQ: GILD) has been one of the fastest-growing biotechs in the world. In recent years, Gilead’s total revenue blasted northward at a compound annual growth rate of 30.1%, according to data compiled by S&P Capital IQ.
Gilead is perhaps the cheapest large-cap growth stock currently on the market. The company became a force to be reckoned with in 2014 when it launched its hepatitis C therapeutic Sovaldi in February and received approval for its hepatitis C combo drug Harvoni in October.
These two drugs alone are expected to bring in ~$3.5 billion per quarter and will go on record as the most successful drug launch in history based on first-year sales.
Gilead’s Sovaldi/Harvoni treatments just recently launched in Europe and Japan, and sales are not expected to peak until 2017 at the earliest.
In addition, Gilead’s market-leading HIV franchise is still showing solid growth at about 10%. Further, the company continues to develop a deep pipeline with promising drugs in late-stage trials.
Gilead’s earnings for 2015 hit $9.28 a share — over four times its earnings in 2013. On a year-over-year basis, quarterly earnings are up a healthy 22.9%.
In spite of this growth, the company still trades at a trailing P/E of 10.79 and a forward P/E of 8.86. Gilead is a clear discount compared to the rest of the industry.
Gilead also boasts a number of other impressive financial figures, which include 51.5% profit margins and $8.61 billion in cash to work with.
In 2016, Gilead saw temporary headwinds due to competition in the hep C market, but we expect by now that sentiment has already been priced heavily into the stock.
Looking ahead four years, Gilead is expected to record significant earnings growth, which is ultimately what you want to see out of a company:
Analysts also project that Gilead will generate huge free cash flows in the range of $15 billion to $18 billion per year over the next five years. This gives management plenty of flexibility to pursue a laundry list of avenues to create shareholder value.
In 2017, we could see a share buyback program, multiple acquisitions of mid-sized competition, debt restructuring, or increased dividends. With pricing as low as it is right now, 2017 will likely prove an attractive entry point for $GILD.
Enanta Pharmaceuticals, Inc. (NASDAQ: ENTA)
Enanta Pharmaceuticals is a development-stage biotech with a strong focus on infectious disease. The company currently generates revenue from its hepatitis C products while developing therapeutics for a liver disease known as nonalcoholic steatohepatitis (NASH).
When it comes to a strategic business model, Enanta runs an incredibly tight ship. The company has been profitable for the last five years, earning over $337 million over the last half decade.
Additionally, Enanta reported $218 million in cash and marketable securities in its most recent quarter.
In terms of liability, the company has less than $3 million in current obligations, putting it in an extremely strong capital position.
Enanta has been able to accomplish all this through licensing fees and periodic but large milestone payments. On a quarterly basis, revenue has been sporadic, but the money is definitely there and will begin to be a bit more consistent in the near future.
In the hepatitis C market, the company currently has strategic partnerships with pharmaceutical giants AbbVie and Novartis. These partnerships have offered extremely positive funding arrangements and are poised to bring in significant royalties and/or milestone payments over the next several years.
In April 2014, AbbVie submitted a new drug application seeking approval for a regimen of hepatitis C treatments that includes Enanta’s ABT-450 protease inhibitor. The regimen was designated as a “breakthrough therapy” by the FDA last year and is expected to be approved.
Further, the regimen is awaiting approval by the European Medicine Agency (EMA) and has already been granted “accelerated assessment.” Both applications generated a total of $40 million in milestone payments to Enanta, which is just a fraction of what will be seen in the future.
Upon commercial approval, Enanta is entitled to receive up to an additional $155 million in milestone payments, as well as royalty payments up to 20% on net sales. For reference, a recently launched rival hep C product (Sovaldi) by Gilead Sciences brought in $2.27 billion in sales in Q1 of 2014 alone.
At the same time, Enanta is in a very similar partnership with Novartis regarding Enanta’s EDP-239 candidate, another hepatitis C therapeutic a bit earlier in the company’s pipeline.
In exchange for commercial rights to EDP-239, Novartis is obligated to reimburse Enanta for the manufacturing and quality assurance of up to $34 million. Enanta would also receive over $400 million in milestone payments through clinical trials and drug approval, as well as royalties in the mid-teens when EDP-239 reaches the market.
Value
As for value, Enanta remains one of the cheapest companies in the industry.
The stock trades at a trailing P/E of 17.5 and a forward P/E of 13.43. The company has virtually no debt, plenty of cash, and is operating at 41.80% profit margins.
With very low debt, hundreds of millions in milestone payments on the way, and plenty of cash on hand, this is a relatively low-risk biotechnology stock.
OPKO Health (NYSE: OPK)
OPKO Health is a young, mid-sized biotech firm that breaks down into two divisions: diagnostics and mid-stage therapeutics. The company’s growth strategy has involved investing in companies with valuable proprietary technology and bringing those products to market.
Diagnostics (Doctor on a Chip)
Within diagnostics, OPKO offers the 4Kscore — a breakthrough prostate cancer screen — as well as a device called the Claros PSA test. The device is essentially a desktop microchemistry lab that allows doctors to receive PSA readings without having to send out the sample.
The benefit of the Claros PSA is twofold: First, the test provides results in as little as 10 minutes at the location where the patient is tested. Second, doctors will be able to hold onto more profit rather than passing it off to outside labs.
We believe patients will prefer these immediate results to the stress of waiting for lab results, while doctors will prefer the long-term financial benefit of keeping diagnostics in house.
In total, nearly 25 to 30 million PSA tests are performed in the U.S. each year. At an average reimbursement of $30 per test, that’s a potential $900 million annual market for OPKO.
OPKO’s in-house testing should capture a significant portion of these tests, providing the company not only with direct revenue from Claros PSA, but also with a solid position to market follow-up 4Kscore testing.
The recent rollout of the Claros PSA reflects the overarching strategy of OPKO’s diagnostics division: in-house or point-of-care testing — something we like to call “doctor on a chip.” The initial target market for OPKO’s desktop lab is prostate cancer, but the company is developing a point-of-care system to address a wide range of applications to include:
- Prostate-specific antigen
- 4Kscore
- Vitamin D
- Testosterone
- Alzheimer’s
- Hepatitis B
- HIV
- Syphilis
- Fertility
- Menopause
- Cardio panel
Because of the convenience and financial benefit of point-of-care diagnostics, we expect OPKO to have strong penetration in whichever of these markets management decides to pursue.
Therapeutics
OPKO’s drug pipeline runs incredibly deep. The company is developing products to treat a variety of conditions including Parkinson’s, obesity, hemophilia, influenza, and kidney disease, just to name a few. We won’t go into every therapeutic in this report, but we will touch on OPKO’s top product candidates in terms of revenue potential.
Rayaldee
Rayaldee is a new vitamin D formulation (yes, vitamin D) drug designed as a treatment for patients with stage 3 and 4 chronic kidney disease (CKD). The candidate met primary endpoints for Phase III trials in late 2014 and has the largest market potential of any of OPKO’s candidates.
The drug has received heavy attention recently, with an NDA (new drug application) filed and approved in 2015. The drug will target approximately 4 million patients in the U.S. alone at a price of about $4,000 per year of treatment. Based on this, we calculate a potential market size of $16 billion.
The current commercial landscape for Rayaldee is ripe for the taking. Existing treatments for CKD are either ineffective or have significant safety issues, and Rayaldee’s clinical results compared favorably to what’s currently available on the market: nutritional vitamin D and hormones.
Credit: BioTrends Research Group, Inc.
With a significant portion of the market left untreated due to safety and efficacy concerns, OPKO’s Rayaldee should take a significant share since its FDA approval.
Rolapitant
Rolapitant is a treatment for chemotherapy-induced nausea and vomiting (CINV) — an increasingly common condition in patients with cancer. CINV is estimated to afflict upward of 70% of cancer patients undergoing chemotherapy. If not prevented, CINV can result in a delay or even discontinuation of chemotherapy treatment.
OPKO originally purchased Rolapitant for $2 million and flipped it to drug company Tesaro for $6 million, a 10% equity stake in the company, and further related payments. OPKO is looking at $115 million in milestone payments from Tesaro ($30 million in regulatory and initial sales milestones and $85 million in annual net sales milestones), as well as double-digit royalties on all sales.
Clinical data from three separate and completed Phase III studies suggested that Rolapitant is the most effective treatment developed right now. Patients taking Rolapitant consistently had higher completion rates in chemotherapy programs and higher rates of no nausea, which would suggest strong market penetration on approval. It’s estimated that peak sales for the drug may be as high as $1.5 billion.
hGH-CTP
In 2013, OPKO purchased Israeli biotech company Prolor, obtaining the rights to hGH-CTP — an orphan drug in the U.S. and EU designed to be a substantial upgrade to standard human growth hormone (hGH) replacement therapy.
The drug is based on a carboxyl terminal peptide (CTP) platform, which makes it possible for patients taking hGH-CTP to only need one injection per week versus one per day as with traditional hGH therapy. Think time-release oral capsules, but for an injection instead.
In Phase III trials, hGH-CTP has already shown comparable measurements to current treatments on both safety and efficacy. Combined with the added convenience of once-a-week injections, we expect hGH-CTP to take a large chunk of the $3 billion-plus market.
At least one big pharmaceutical company seems to agree with this thesis, as OPK has already entered into a global development agreement with $215 billion drug manufacturer Pfizer (NYSE: PFE) regarding hGH-CTP.
The Pfizer agreement included a $295 million upfront payment and up to an additional $275 million in milestone payments. OPKO will be eligible for royalty payments upon commercialization.
Financials and Recommendation
As of its most recent quarter, OPKO reported cash and cash equivalents of $221 million, already providing the company with strong liquidity and the ability to continue the development of its many product candidates.
OPKO has continued to increase R&D spending related to its ongoing Phase III programs such as hGH-CTP and has recently incurred costs associated with a clinical validation study for the 4Kscore.
With the 4Kscore now on the market and several Phase III candidates approaching commercialization, though, we expect these operational costs should drop substantially, pushing OPKO towards the green.
OPKO’s current burn rate is approximately $40 million a quarter, giving the company several more quarters of working capital. Of course, this scenario would assume zero growth on the top line and an extension of current clinical trials — neither of which we’re expecting to happen.
OPKO’s 4Kscore first launched in March 2014, meaning the full effect of revenues are still just being realized. We’re expecting further traction in 2017.
