It seems a rising tide does not lift all boats; the S&P 500 has risen 11% following President Donald Trump’s victory last November, but the NASDAQ Biotechnology index is up just 2%.
Mega-cap global biotech companies are trading at a significant discount to the major US pharmaceutical stocks and the S&P 500, according to a report by Stifel. This is reflected in the closed-end funds in the sector too; the Silver Rated Biotech Growth (BIOG) is trading at 7.6% discount, the lowest level of valuation since 2011, while International Biotech (IBT) is trading at 6.4% discount.
Megacap global biotech companies are trading at price to earnings multiples of 13 times, US pharma stocks are trading at 17 times and the S&P 500 is at 25 times. “It is rare for a sector with higher forecast growth rates to trade at a discount to the wider US market,” added Anthony Stern with Stifel.
President Trump and Drug Pricing
Since the beginning of the year, President Donald Trump has been vocal about his concerns regarding high drug pricing in the US. In March 7, President Trump sent a tweet promising to lower drug prices, putting pressure on pharmaceutical shares. He wrote: “I am working on a new system where there will be competition in the Drug Industry. Pricing for the American people will come way down.”
President Trump’s tweets may confuse and worry generalist investors, but the long-term outlook remains positive for biotech firms – and there are opportunities for investors, said David Holder, fund analyst with Morningstar.
“Valuations are reasonable in biotech investment trusts when compared to other parts of the market and to their history. Areas of optimism surrounding potential M&A activity, a supportive US regulatory environment, strong scientific innovation and supportive demographics in both the western and emerging world,” said Holder.
Stifel’s Stern agreed, saying that concerns about drug pricing are overblown.
“The pricing issues of the US politicians are not with innovative drugs developed by the biotech companies but with the price gouging for old, off-patent drugs. Furthermore, as evidenced by President Trump’s struggle to restructure Obamacare, the US healthcare system is complicated and difficult to reform and changes are unlikely to be as significant as the market fears and also slow in coming,” said Stern.
Demand for New Drugs Remains High
The approval rate for drugs by the US Food and Drug Administration, the US regulator that supervises drugs products, can be used as an indicator for innovation in the biotech industry, said Stern.
In 2016, just 25 new drugs were approved, which was down on the 56 approvals in 2015 and 50 in 2014. The average for the past 10 years is 36 new drug approvals annually. Whilst the level of 2016 approvals was low, it is likely that the number was depressed due to the high levels achieved in the prior two years, Stern explained.
According to a report published by Ernst & Young, the global advisory service provider, biotech’s financing activity decelerated in the fourth quarter of 2015, mirrored the decline of the NASDAQ Biotech Index, which fell 21% during the month of January 2016.
“The drops in financing and valuations in the biotech sector may be equally precipitous, but that’s in large part because each rise was historically impressive,” the report read.
The biotech sector has fallen from favour since then. However, the innovation is still very much there, said William Ball, an analyst with Sanlam.
“There is a huge push of innovation within research and development, especially on drugs addressing health issues in developed markets: research shows that one in four people get lung cancer in these countries while one in five women get breast cancer,” said Ball.
Morningstar analysts agreed, saying that the innovative therapeutic areas of cancer, immunology, multiple sclerosis, and vaccines are poised for strong pricing power as the innovation is powerful enough to provide the drug companies better leverage in negotiations with the payer group.
High Commonality Between Biotech Trusts
Of the top 10 holdings of three biotech investment trusts, Biotech Growth, International Biotechnology and Biotech, there is significant amount of commonality between them.
Four names appear in the top 10 holdings of all three funds accounting for between 22% and 44% of their portfolios. Biotech Growth and Internaiontal Biotechnology have eight of their top 10 holdings in common.
“Given the concentration of the benchmark, the Nasdaq Biotechnology Index, which 60% of the index in the top 10 holdings, high levels of commonality are not surprising,” said Stifel’s Stern.
Performance of the Biotech Growth trust, which is Silver Rated by Morningstar anlaysts, is measured against its benchmark index, the Nasdaq Biotechnology Index, with sterling adjusted, said Morningstar’s Holder.
“The strength of the proposition comes from the in-depth knowledge that the investment team brings to this fast-paced and specialist market. We think investors looking for biotech exposure are in safe hands with Biotech Growth Trust,” Holder added.
However – before investors jump into to this niche market, it is worth remembering biotech is best deployed as a small satellite holding within a well-diversified portfolio as it can be a volatile sector.
