The four best bets in the biotech sector

Investing in biotechnology stocks has never been for the fainthearted, says Piper Terrett in Shares. The numerous clinical trials that drugs have to go through to get to market means that each one costs its developers a good £100m. Having said that, there is huge opportunity in the sector. The world population is ageing fast, there has been an explosion in "lifestyle diseases" such as diabetes, and at the same time the pipelines of possible solutions at the big pharmaceutical firms are drying up. Here are four biotechs that could come out on top.

First is Acambis. The departure of its chief executive has "put the wind up" investors, hitting the share price and creating a buying opportunity. The firm has "very lucrative" smallpox contracts with the US government and is both cash generative and profitable. Concerns that its medium-term drugs pipeline looks "a bit thin" are offset by its potential as a takeover target for US companies looking to get into vaccines.

Second is Oxford Biomedica. The firm has a "revolutionary" cancer vaccine, TroVax, which works by delivering a gene to the cancer cell via a pox virus and is currently in Phase II trials. Also good news is that its breast cancer treatment, MetXia, has received approval to enter Phase I/II trials in patients with pancreatic cancer, for which there is currently no treatment. Cancer drugs have a high rate of failure, but the firm is well funded. The shares look attractive at 18p; there is much to play for.

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Neutec Pharma is another good buy. The hospital-acquired infection MRSA kills more than 200,000 patients in the US and the UK every year, something the firm is aiming to tackle with new drug Aurograb. Aurograb is made from the antibodies of patients who have contracted the antibiotic-resistant disease but lived to tell the tale. Recent trial data is promising. Also looking hopeful is Mycograb (for candidiasis), which is closer to market and may also have potential as a cancer treatment. Losses may rise at Neutec this year due to research and development costs, but there is £12m in the bank.

With its large portfolio of drugs for obesity, irritable bowel syndrome and mucositis (a condition affecting cancer patients using chemotherapy), Alizyme is one to watch. It has performed strongly this year, leaving its stock "looking a bit pricey". But the prospects of US and European licences for its obesity treatment, ATL-962, look good. The Japanese licence went for up to $42m. Alizyme has no revenues but it is well funded and its attractive drugs pipeline makes it a prospective takeover target.

Plenty of potential at Hydro InternationaThere is no such thing as guaranteed demand, says Investors Chronicle, but it helps when regulations "point customers your way". Such is the case with Hydro International, which sells products for controlling the quantity and improving the quality of both stormwater and wastewater. The UK water industry's current programme of improvements means that the ten British water and sewerage companies and the 13 water supply companies will have to spend a total of £5.3bn over the next five years. Hydro is well placed to meet not only this demand, but to increase sales across Europe, where potential will be boosted by wastewater directives and an expanding EU. Further growth may be stimulated by US legislation. Underlying growth already looks good. Sales shot up by more than 60% to £5.5m in the first half, while profits doubled to £655,000.

It hasn't always been like this. High costs and over-ambitious expansion led to profits warnings a few years ago. But a new management team, installed in 2000, has restored focus, leaving the firm with a strong product range and plenty of potential. Management has also kept expansion plans nicely in check over the last few years, says the Chart Breakout newsletter. In countries such as Japan, where Hydra does not intend to have its own operations, it licenses its technology out. Hydra has also been concentrating on balance sheet strength, which explains why it has only just begun paying dividends. Its interim results and the legislation driving rising standards in water quality make the firm's prospects "look excellent". The shares, at 130p, have now staged "a powerful breakout" from trend. Expect a rise to 240p.

Cardpoint capitalises on cash machine withdrawalIn just four years, "whizzkids" Mark and Nigel Mills - who had already established and sold a successful postbox installation firm - have built Cardpoint into Britain's third-largest independent provider of automatic teller machines (ATMs), says Red Hot Penny Shares. Growth since its flotation on Aim in 2002 has been rapid: "backed by enthusiastic City institutions", it has made a series of acquisitions and increased its number of ATMs from 188 to more than 2,000. The most significant deal was the £9.2m takeover of Securicor Cash Machines in May this year. This not only allowed Cardpoint to quadruple in size overnight, but looks "smart" given that it has signed a four-year outsourcing arrangement requiring Securicor "to do all the dirty work", including installing, maintaining and filling the machines. Cardpoint receives a "fat" £1.50 for every cash withdrawal, in addition to about 20p from banks for each balance enquiry. Turnover has grown ten-fold to £11m in just two years, allowing it to negotiate better terms from suppliers, which should help it break into the black next year to the tune of £1.9m.

And the group's "exciting growth" is set to endure. The cashless society is a long way off. The annual cash machine withdrawal in the UK has doubled to £2.3bn over the past decade, and is expected to climb to £3.1bn by 2011. And while the market is dominated by ATMs in bank branches, the number installed by independent operators climbed 47% last year. Growth will be underpinned by new applications. The Government is planning to automate benefit payments by April 2005, thus facilitating their collection from a cash machine. Mobile phone operators will also spur greater use of ATMs as they are phasing out pre-paid vouchers. Cardpoint has joined an agreement between the national Link network of cash machines and Vodafone, which allows the latter's customers to top-up their airtime on Cardpoint ATMs. Once the City grasps the potential of cash machines, expect Cardpoint's shares "to soar" to 125p by the end of 2004.