Where to find the pick of the bunch in biotech stocks

Each week, a professional investor tells us where she’d put her money. This week: Ailsa Craig of the International Biotechnology Trust chooses three promising small caps.

Biotechnology remains an exciting sector, but investors need to be far more discriminating now than they were a few years ago. Growth at the largest firms has slowed, as popular products have reached their peak sales potential. There is now more scope for long-term earnings growth in smaller and medium-sized companies.

However, many of the smaller firms carry greater risk than their larger counterparts. They often do not have well‑established portfolios of existing drugs and future earnings depend on the launch of new products. Also, drug development is a challenging, long-term business with no guarantees of success.

To avoid undue risk, investors should select companies with products that generate revenues and profits, and also have long-term patent protection. Here are three stocks that match this profile.

Turbulent but promising

Incyte (Nasdaq: INCY) has had a turbulent 18 months. It was developing a new type of cancer therapy – an ‘IDO-inhibitor’, which works by stopping cancer cells from hijacking the IDO protein, which can suppress the immune system.

There were high hopes for the treatment, but a final study in April revealed the treatment regime was ineffective. As a result, the share price fell sharply and the stock is now trading at less than half the value it reached at its peak.

Despite the failure of the IDO-inhibitor, all is not lost. Incyte’s multi-billion-dollar drug, Jakafi, is used to treat patients with a rare form of blood cancer for whom existing treatments are ineffective. Jakafi has recently received approval for a second indication – in other words, it could be used for another disease – and strong growth is expected to continue.

The company also has a lucrative agreement with Eli Lilly for another recently-approved product, Baricitinib, which is expected to generate additional revenues in the medium-term.

A cystic-fibrosis specialist

Vertex (Nasdaq: VRTX) has a significant market cap, but it does not have the structural problems of other large biotech companies. The company specialises in the treatment of cystic fibrosis; its product, Kalydeco, works by modifying the disease, and is very effective.

As cystic fibrosis only affects a relatively small number of patients, the company has received ‘orphan drug’ status for Kalydeco. This permits the company to charge a high price for the drug and the compound is protected from competitors. In addition, Vertex owns the drug outright so it is not sharing profits with a larger partner. Earnings-per-share are set to double over the next three years.

Attacking early-stage cancer

Genmab (Copenhagen: GEN) currently has two drugs on the market, one of which is Darzalex. The main growth-driver, this compound is a monoclonal antibody used to treat multiple myeloma, a rare form of cancer.

Darzalex is now approved for use in patients with earlier stages of the disease, which should give Genmab’s revenues a considerable boost. The company is also developing a formulation of the drug that is easier to administer, which will cut infusion time substantially. This will lead to increased patient numbers and improve their quality of life.