Thanks to new drugs, acquisitions and other factors, biotech and health-care firms alike are forging beneficial growth and development strategies – which is good news for investors.
Jason Kantor, Ph.D.RBC Capital Markets [email protected]
An increase in M&A among earlier-stage public [biotechnology] companies is likely and would enhance investor confidence in small-cap stocks. Large-cap companies with good earnings have performed well and will likely continue to do so.
We continue to favor large-cap biotech companies particularly industry leaders with multiple years of visible growth … In the small-cap space, individual stock performance has become substantially de-linked from company fundamentals. We favor companies with near-term clinical catalysts and reduced near-term financing needs, such as Alexza and Allos. Investors with longer-term horizons can find deep value in many of the small-cap companies that despite solid clinical progress are trading at very low enterprise values.
We believe the best valuation metrics for biotech companies are price/earnings and price/earnings to growth. Currently, the top-tier biotech companies … trade at a mean of 23.6 times 2008 consensus EPS estimates and at a PEG of 1.1 times. These metrics are significantly below their historical averages.
In comparison to the 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.
The biotech sector is now trading at a significant PEG discount to both pharma and its long-term historic average, indicating to us significant room for upside in the group through multiple expansions. The biotech sector is trading below its eighth-year historical PEG of approximately 1.64 times earnings. Even excluding the “bubble years,” the historic PEG is substantially higher than current levels (1.47 times for 2002-2008).
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 depressed valuations make the sector very attractive for investors willing to ride out the current cycle.
We believe that the growth prospects for biotech remain strong, and innovation and investment in the first half of the decade are now generating new products and better understanding of disease processes.
Outperform: Affymax (AFFY), Alexza (ALXA), Allos Therapeutics (ALTH), Avigen (AVGN), Curis (CRIS), Cubist (CBST), Epix Pharmacueticals (EPIX), Genentech (DNA), Gilead Sciences (GILD), ImmunoGen (IMGN), Medivation (MDVN), Micromet (MITI), Progeneics (PGNX), Regeneron (REGN), Seattle Genetics (SGEN), Synta (SNTA), TorreyPines (TPTX), Xenoport (XNPT), and Xoma (XOMA).
Douglas Maurer, CFAValue Line 212-907-1500