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Invest in the next miracle drugs
Biotechs have soared in a tumultuous year, but theres still room to grow -- if you catch a small company with the right drug in the pipeline.
By Michael Brush
Nobody promised investors a smooth ride in a sector where success can hinge on the proper harvesting of mice antibodies.
And true to form, it's been a wild ride in biotech this year. After getting clobbered in March and April, the Nasdaq Biotech Index is up 25% -- nearly three times the advance of the Standard & Poors 500 index.
Despite such gains, biotech sector experts think theres still time to jump on the bandwagon. "I continue to anticipate a strong sector through the fall and next year," says Gregory Wade, who covers biotech stocks for Pacific Growth Equities.
Why the sector still has legs
The experts chalk up the groups strength to three factors:
The FDA's teeth aren't as sharp as folks think.
Biotech stocks took a nosedive in the spring after Biogen Idec (BIIB, news, msgs) pulled its multiple sclerosis drug Tysabri because of concerns that it could make patients susceptible to a rare brain disease. Coming on the heels of Merck's (MRK, news, msgs) Vioxx debacle, the Biogen news reinforced fears that Food and Drug Administration approval would slow to a crawl as the agency scrutinized new drugs more closely.
Its now clear those worries were overblown, as product approvals continue to flow. "The FDA is maintaining a balance between safety and efficacy," says Jay Markowitz, a biotech analyst with fund company T. Rowe Price Group.
Just last week, for example, an FDA panel approved an experimental Bristol-Myers Squibb (BMY, news, msgs) drug called Pargluva for diabetes, the first of a new class of diabetes treatments that dont use insulin. A panel also approved inhaled insulin from Pfizer (PFE, news, msgs), called Exubera. "I was very encouraged," says Markowitz.
The FDA still has a bias in favor of therapies that treat horrible and hard-to-cure ailments like cancer, says Ron Garren, a practicing physician and medical researcher who publishes the Biotech Insight newsletter.
"I dont think the FDA is a threat for drugs that really meet unmet medical needs," he says.
Related news and commentary on MSN Money
Big Pharma still has a big appetite.
Many big pharmaceutical companies have high-revenue drugs about to lose patent protection. Meanwhile, their drug pipelines are running dry. The result: They are snapping up biotech companies to replenish the pipelines, says Jrme Pfund, a money manager at the Montreal-based Sectoral Asset Management.
Recently, for example, Pfizer announced plans to buy Vicuron Pharmaceuticals (MICU, news, msgs). GlaxoSmithKline (GSK, news, msgs) said it would buy Canadian flu-vaccine maker ID Biomedical Group (IDBE, news, msgs). And Swiss giant Novartis (NVS, news, msgs) bid on the remaining shares of vaccine maker Chiron (CHIR, news, msgs) that it didn't already own.
Biotech analysts expect the buyout binge to continue. Snapping up little biotechs "is a source of new products," says Jordan Schreiber, who manages the Merrill Lynch Healthcare Fund (MDHCX). A new tax break on repatriated earnings for multinationals will support this trend, says Garren, by putting more money in the companies' pockets.
Drug-trial results are on their way.
Over the next few quarters, were likely to see important study results in three main disease groups -- cancer, diabetes and cardiovascular ailments, says Sunaina Murthy, an analyst with the AIM Global Health Care fund (GGHCX).
Look for developments at conferences sponsored by the Heart Failure Society of America later this month, and at December meetings of the American Society of Hematology and the Interscience Conference on Antimicrobial Agents and Chemotherapy. The annual JP Morgan Health Care Conference in January should also bring to light a flurry of study results.
Whats the best way to play these trends? Our experts say the key is to own biotech companies with products in the late stages of development.
Too big to buy
Amgen (AMGN, news, msgs) and Genentech (DNA, news, msgs) -- the twin giants in the biotech group -- may be too big for a buyout. But there are plenty of other reasons to like their stocks.
Amgen shares are up 35% since early July. The company blew away Wall Street analysts' estimates and raised its earnings guidance in mid-July, thanks to 25% to 45% sales gains for key products like Aranesp, Epogen, Neulasta, Neupogen and Enbrel, drugs for anemia, infection associated with cancer treatment and arthritis.
The next six months could bring positive late-stage trial results on Amgens Panitumumab, which treats cancer by blocking the signals that tell cells to grow out of control. We could also see positive results on Denosumab, an osteoporosis treatment. Other studies may show Aranesp can be used to treat congestive heart failure.
Like Amgen, Genentech, has a fairly rich valuation following monster gains this year, an increase of 50% since mid-April. Genentech has something else in common with Amgen: promising drugs on the way. So despite the strength of its stock, Genentech remains a core holding in many health-care funds.
Genentech is best known for blockbuster cancer drugs like Avastin. It fights cancer by stifling the growth of blood vessels that tumors need for nourishment. Other cancer-fighting drugs in Genentechs stable include Rituxan, Tarceva and Herceptin. Each has been approved for specific types of cancer. But theyre likely to work against many other kinds of cancer and other diseases, as well. Hundreds of studies are taking place right now to prove this. The company also has a possible treatment for the macular degeneration, called Lucentis.
Genentech will start getting FDA approval for those other applications, says Murthy, noting that the expanded uses will drive revenue growth.
Ripe for the picking
For the real growth in biotech, you have to turn to lesser-known smaller companies that havent rallied as much in recent months. Below are several candidates, most of which have late-stage research that should drive their share prices higher or attract larger suitors. Remember that because of the risks with smaller biotech companies, it is important to own a basket of them. Here they are, in order of market capitalization, largest first:
Protein Design Labs (PDLI, news, msgs) is one of the main sources of technology behind "humanized" mice antibodies, which are tweaked so the human immune system can accept them. Protein Design Labs supplies the know-how that makes Genentech blockbusters like Avastin and Herceptin work. As the list of cancers those drugs treat grows, so will Protein Design Labs' profits. "The stock reflects pretty modest expectations for Avastin sales," says Murthy. The company also has a pipeline of its own drugs that may be use to treat multiple sclerosis, congestive heart failure, colitis and asthma.
Vertex Pharmaceuticals (VRTX, news, msgs) develops treatments for viral diseases like hepatitis and HIV and illnesses like rheumatoid arthritis and psoriasis. Markowitz, of T. Rowe Price, says Vertex has three compounds with "blockbuster potential" currently being tested.
Like Protein Design Labs, Medarex (MEDX, news, msgs) helps develop humanized antibodies from mice. The company is working on more than two dozen human antibody drugs that could target a wide range of diseases from cancer and rheumatoid arthritis to infectious diseases, says Merrill Lynch's Schreiber. Medarex has a multitude of partnerships with big pharma companies.
The flagship drug at Cubist Pharmaceuticals (CBST, news, msgs), called Cubicin, is an intravenous treatment for severe skin infections. Cubist shares could see gains later this year when the company presents study results on the use of Cubicin for endocarditis, a kind of heart infection, and for bloodstream infections, says Wade. The companys pipeline drugs include treatments to prevent hepatitis infections in liver transplant patients.
Atherogenics (AGIX, news, msgs) has a drug that can reduce plaque buildup in the cardiovascular system. The drug, in Phase III trials, is a potential blockbuster that could yield annual sales north of $1 billion, says Murthy. Expect results in first half of 2006.
Exelixis (EXEL, news, msgs) has at least a half-dozen compounds in early or mid-stage clinical study, says Schreiber. Most of them fight cancer. Exelixis has partnerships with Genentech to develop several of them.
Discovery Laboratories (DSCO, news, msgs) is working on a synthetic form of surfactant, which is used to help premature infants with respiratory problems. Discovery Laboratories' stock price has taken a hit because manufacturing issues have held up approval of Surfaxin, the company's synthetic form of surfactant. But the stock looks like a bargain, says Garren, because he thinks the snafus should be resolved by early next year. He says Discovery's Surfaxin would improve on existing forms of surfactant, which are extracted from animals and sometimes contain impurities.
Cortex Pharmaceuticals (COR, news, msgs) is developing a drug that may improve alertness and memory by changing how nerve cells in the brain communicate. It could be used to treat problems like Alzheimers, sleep deprivation, autism and attention deficit disorder. Garren says that the drug's animal-testing studies look promising, and that by end of year "we may know more about its efficacy in humans."
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