Biotech: a refuge for panicky investors?

With financial markets in turmoil, the biotech sector is one of the few that stands out as a refuge for panicky investors, says Eoin Gleeson.

Every autumn, the biotech industry gathers at the annual round of medical conferences to announce results of clinical drug trials and show their wares to doctors. News flows, investors get excited, shares rise and optimism abounds. Then nothing happens. But this year, there might actually be a reason to hold biotechs beyond the conference season. With financial markets in turmoil, the biotech sector is one of the few that stands out as a refuge for panicky investors.

For a start, biotech looks comfortably removed from the troubles in the financial sector. Biotech firms are mostly financed with equity, rather than debt, notes Brett Scott on Seeking Alpha, and buyouts in the sector tend to be cash-based. So big pharmaceutical companies, facing a dearth in their drug pipelines, won't be dissuaded from picking up a few biotech firms because of the problems in the credit markets. The market for health treatments should also remain healthy. Even if consumers cut back, the ageing and increasingly overweight populace has an ever-growing need for innovative drugs. As Jim Cramer reflected in one of his calmer moments, "as the economy slows, you want to own biotech".

The sector also looks good value. Large-cap biotech stock valuations are at a five-year low, despite the fact that biotech firms beat Wall Street's earnings-per-share expectations by between 6% and 13% in the second quarter, say analysts at Bernstein Research. That may be partly down to the Food and Drug Administration (FDA) acting tough on drug approvals the market may be pricing in fears that more biotech drugs are likely to hit a brick wall going forward. Only 63% of drugs released this year have made it past the regulator, compared with 73% last year.

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But fear of the FDA is misplaced when it comes to biotechs, says Bernstein Research's Geoffrey Porges. These firms "tend to be developing treatments for serious, often life-threatening illness", he says. "Such treatments are not subject to the same risk of serious side-effects in broad usage", unlike mass-market, widely used drugs for common conditions. In the UK, the sector has also taken a hammering as investors flee to large caps, says Sylvia Pfeifer in The Sunday Telegraph. This has hit biotech particularly hard because there are few specialist fund managers covering the sector. That means there are fewer buyers out there bargain-hunting when times get tough. But this does mean there are some very cheap-looking stocks around. For example, in the cases of both BTG (BGC) and Protherics (PTI), says Sam Fazeli of Piper Jaffray, the market is actually attributing a negative value to the products they have in development. Protherics's asset value is around 55p, but its shares are trading at 47.25p. The market appears to think that its new drugs the group specialises in cancer treatment and critical care will actually devalue the company. "Where is the logic in this?" asks Fazeli.

So what kind of biotechs should you take a look at? Well, there are promising areas that could lead to great breakthroughs, such as stem-cell research. But now is not the time for laying bets on blue-sky' technologies. What you really want is a biotech with a promising pipeline of drugs and a sound business with steady demand companies that have partnerships with big pharma. In the box below, we have a look one company that we think is worth considering.

The best bet in the biotech sector

Aside from BTG and Protherics (see above), one biotech firm that looks particularly cheap at the moment is Canada's biggest listed drugmaker, Biovail (NYSE:BVF). The company recently suffered a 25% writedown in its shares after the FDA rejected a new drug application for a once-daily version of its flagship anti-depressant, Wellbutrin. It was hoped that the new version would help the firm combat growing generic competition to the drug, which is sold by GlaxoSmithKline. But despite the disappointment, on a forward p/e of 10.9, Biovail looks far too cheap, given that it has ten new drugs in the pipeline and another four approaching the new-drug application stage.

Biovail has carved out a niche in designing different delivery methods for existing off-patent drugs, including slow-release tablets, inhaled and oral delivery methods. These delivery technologies are proving popular with big pharma, as they can be used to extend the lifetime of a drug before it goes off patent.

The oral delivery market alone is expected to grow by 48% to $52bn in revenues by 2020. And Biovail's focus on pain management and cardiovascular disease means that it should see growing demand as the baby-boomer generation continues to age. The company offers a very attractive 8.7% dividend yield.