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After a Breather, Biotech’s Rally Is Back

17 December 2014 in Trading Ideas

You know things are going well in a sector when both growth and value investors are finding ways to get in.

Such universal popularity has helped push biotech to outperform the broader market this year by a wide margin, particularly over the past six months. The Biotech Breakthroughs motif, for example, has gained 24.1% since mid-June. In that same time frame, the S&P 500 has risen 4.8%.

In the past month, the motif has increased 2.2%; the S&P 500 is down 1.6%.

Illustrating the attractiveness for investors of different stripes is Gilead Sciences, which has a 17.3% weighting in the Biotech Breakthroughs motif.

As a recent Barron’s article noted, shares of Gilead have a relatively low valuation, despite the fact that the Food and Drug Administration approved in October the company’s hepatitis C drug, Harvoni. It’s expected to log $1.4 billion in sales in the fourth quarter alone.1

Brian Lazorishak, portfolio manager of the Chase Growth Fund, told Barron’s that “a lot of traditional value companies are trading at a higher multiple than Gilead.” Shares of Gilead trade at 10.5 times its forward 12-month earnings vs. 17 times for the entire S&P 500.

Lazorishak suggested that while some discount might be warranted due to the uncertainty over future drug sales, the attractive valuation already discounts the possibility of things going wrong.

For Barron’s, a worst-case scenario appears less than likely. Its competition isn’t yet threatening in the hepatitis C space, where Gilead now has first-mover advantage. Meanwhile, given the fanfare surrounding the expectations behind Harvoni , Barron’s noted that investors may be giving short shrift to the company’s $9 billion HIV business and research in other areas.

In addition, the growth investing story has been buoyed by the company’s strong financial position and its use of free cash flow to repurchase shares, Barron’s said. Return on equity, approaching 30%, is one of the highest of its peers, as are its gross profit and operating margins. The company recorded record cash flow last year and has been reducing its long-term debt, which was just over 20% of its market value at the end of 2013, down from more than half in 2011, according to the article.

Yet the feel-good vibes aren’t limited to Gilead. Celgene, which comprises a 12.4% weighting in the motif, has seen its stock rise more than 40% in the past year, rising by one-third in just the last two months.

Celgene’s star shot higher earlier this month on the strength of data it released at the American Society of Hematology conference.2 Cantor Fitzgerald analyst Mara Goldstein noted after the meeting that the company appears to have a “strong tailwind” heading into 2015, based on the volume of data supporting its core hematology franchise, as well as the potential from partnered assets.

With Celgene likely to continue enjoying operating leverage, Goldstein wrote that she believed there’s a continued opportunity for rising EPS forecasts. She raised her own estimate and upped her price target on the stock to $131 — a 15% upside from its current level.

With biotech’s brightest lights continuing to impress Wall Street and reward investors for showing faith in the future, the sector’s rally may have more room to run.

1Teresa Rivas, “Gilead Is Growing Fast And Its Stock Is Cheap,” barrons.com, Dec. 11, 2014.

2Ben Levinsohn, “Celgene: The New Biotech Fave?,” barrons.com, Dec. 8, 2014.

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