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March 01, 2008 at 02:00 AM
Stocks in health care, including biotech and pharmaceuticals, are poised for higher levels in 2008 – thanks to present valuations, developing pipelines and acquisition horizons, analysts say.
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Jason Kantor, Ph.D.RBC Capital [email protected]
Sector Outlook: Concerns over competition in monopoly franchises have led to significant P/E contractions for the big-cap biotechs in 2007 and created an attractive entry point for many stocks.
We continue to expect M&A to be an important growth strategy for large-cap biotech companies, and late stage small- to mid-cap biotech companies should remain targets for both large-cap biotechs and big pharma companies.
In the big-cap space, we recommend sticking with the high-quality stocks with solid revenue growth and the least exposure to regulatory and political headwinds, and looking forward to potential sentiment changes for more out-of-favor names. In the smaller-cap space, we recommend later-stage companies and recommend owning a basket of stocks with upcoming catalysts.
Merger and acquisition activity has been on the rise since early 2005, with many of the large pharmaceutical companies and major biotechnology companies participating in this shopping spree. The pace of M&A activity has increased significantly in the past 12 months, with six deals valued at more than $1 billion in 2007. The driving force behind the increased M&A has ranged from marketed products to late-stage product candidates to early-stage technology. Among publicly traded targets, nearly all have had late-stage or marketed products.
We believe that the best valuation metrics for biotechnology companies are P/E (price to earnings) and PEG (price/earnings to EPS growth). Currently, the top-tier biotech companies trade at a mean of 21.3 times 2007 consensus EPS estimates and at a PEG of 1 times. These metrics are roughly in line with their historical averages.
In comparison to large pharmaceutical companies, biotech has historically traded at a higher P/E multiple (consistent with higher growth rates), but the premium over pharma is at a multi-year low. Although the valuation gap between biotech and pharma is narrowing, currently the biotech sector is trading at a PEG discount to both pharma and its long-term historic average, indicating to us significant room for upside in the group through multiple expansion.
We believe that we are in a period of rapidly improving fundamentals in biotech (more products, more profitable companies, more retained product rights, etc.), so we believe that the currently depressed valuations make the sector very attractive for investors willing to ride out the current cycle. The depressed valuation is attributable to increased risk premiums and the fear of slowing growth for some of the larger companies. We are already seeing improvements in the risk premium for smaller companies, and current growth projections for many of the larger companies may underestimate the value of the current pipelines and acquisition opportunities, in our opinion.
Genentech (DNA) Outlook: We maintain our Outperform rating and believe that 2008 will be defined by four key events which should provide important visibility on incremental sales growth: (1) Avastin PDUFA (Prescription Drug User Fee Act) data for breast cancer in February, (2) Phase III Rituxan data for lupus in the first half of 2008, (3) Phase III Rituxan data for multiple sclerosis in the first half of 2008, and (4) most importantly, Phase III data for Avastin in adjuvant colorectal cancer. We believe the stock is relatively cheap at 20 times our 2008 EPS estimate of $3.40 and would be buyers of DNA particularly based on our expectation for positive adjuvant Avastin data which should re-accelerate sales growth in 2009 and beyond.
In our view, the positive thesis for Genentech remains intact given its growing robust pipeline, potential new blockbuster indications for existing products, and ongoing operational execution. We expect a number of events in 2008 to provide better visibility on outer year sales growth.
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Charles C. Duncan, Ph.D. JMP Securities [email protected]
Felicia Miller, Ph.D. JMP Securities 212-906-3505 [email protected]
