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Four undervalued biotech stocks

After a severe correction, these stocks now look a lot more attractive.

Vikram Barhat 11 March, 2016 | 6:00PM
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Biotechnology had a dream run over the past five years, returning more than 200% leading up to the second half of 2015, when the red-hot sector took a beating resulting from a widespread selloff. Industry watchers say the correction was overdue and that it served to allay fears among investors over a possible return of the 80s biotech bubble.

Since coming off record levels, however, the sector has become a safer play for investors pushed to the sidelines by astronomical valuations. The S&P Biotechnology Select Industry Index was down more than 33 % over the first two months of 2016, while the Nasdaq Biotechnology index was down about 27%, for the same period.

Biotech stocks are companies that discover new therapies to treat or cure medical conditions. Although the sector experiences boom and bust cycles driven by political, economic, regulatory and competitive pressures, it offers sound investments choices for long-term investors. Judging by their above-average Morningstar ratings, a few biotech firms may be well positioned to outperform the market in 2016.

According to Morningstar equity research, biotech companies with a reputation for innovation, strong product portfolio and robust R&D pipelines will continue to grow through mercurial market sentiments, patent maturity and short-term events.

Amgen Inc.
Ticker AMGN
Current yield 2.39%
Forward P/E 11.5
Price US$140.90
Fair value US$194
Data as of Mar. 9, 2016

A leader in biotechnology-based human therapeutics,  Amgen (AMGN) discovers, develops and makes medicines for life-threatening conditions like kidney disease and cancer.

"Amgen markets several blockbuster biologic therapies in the oncology and immunology markets, giving it the intangible assets that form the foundation of its wide moat (competitive advantage)," Morningstar strategist Karen Andersen said in a report.

Drugs like Enbrel, which accounted for 25% of sales in 2015, and Repatha, poised to be the top product by 2025 and currently making up 18% of sales, fuelled robust growth against competitive headwinds. The company's cancer treatment drug Prolia and renal disease drug Sensipar have also reached blockbuster status, she added.

The five-star-rated firm's highly profitable biologics drive a more than 30% free-cash-flow-to-sales ratio. Further, large-scale cost-cutting and improved manufacturing mean the company will "continue to see free cash flow margins improve, and return on invested capital to remain above its cost of capital for the foreseeable future," said Andersen, who pegged the stock's fair value at US$194. "The firm is capable of average annual 1% top-line growth and 3% bottom-line growth through 2020.

Andersen projects US$2.5 billion in biosimilar sales for Amgen in 2025, and for the firm's adjusted operating margin to improve from 38% in 2013 to 53% in 2019.

Gilead Sciences Inc.
Ticker GILD
Current yield 1.47%
Forward P/E 7.2
Price US$87.83
Fair value US$128
Data as of Mar. 9, 2016

 Gilead Sciences (GILD) develops and markets therapies for life-threatening infectious diseases, with primary focus on HIV, hepatitis B and C, pulmonary and cardiovascular diseases, and cancer.

The five-star-rated company's strategic focus on infectious disease has paid rich dividends, Andersen said in a Morningstar report. "With a small salesforce, inexpensive manufacturing and selective research and development, it generates stellar profit margins," the report said, stressing that "the firm's pipeline is extending its reach from HIV into other high-margin markets like hepatitis C and hematological oncology."

The wide-moat company's sustainable competitive advantage rests on its leadership position in the treatment of HIV, with three patented products. "Gilead serves almost 80% of treated HIV patients in the United States," said Andersen, who put stock's worth at US$128. "Patent protection on newer HIV regimens and Gilead's continued innovation in the hepatitis C market will be enough to ensure strong returns for the next couple of decades."

Given that sales of its current line-up of drugs have either reached or are nearing peak, the company is expected to be looking for a potential acquisition target to help fuel future growth. The firm's management is known to use massive cash flows for acquisitions like Pharmasset, an US$11-billion takeover that is considered one of the shrewdest deals in the industry's history.

Biogen Inc.
Ticker BIIB
Current yield -
Forward P/E 12.6
Price US$255.66
Fair value US$400
Data as of Mar. 9, 2016

 Biogen (BIIB) develops, manufactures and markets novel drug therapies for multiple sclerosis and cancer. The company also has several drug candidates in phase 3 trials in the fields of immunology and neurology.

The drugmaker derives strong profitability from the success of three marketed products in the fields of oncology and neuroimmunology, and the introduction of Tecfidera, which helped the firm gain a dominant share of the US$80 billion multiple sclerosis market, according to a Morningstar report.

The five-star-rated, wide-moat company "has a strong R&D strategy for maintaining its leadership in multiple sclerosis, where pricing power is strong, patient need for novel therapies is high, and the pipeline has been particularly productive," said Andersen, who pegged the stock's fair value at US$400.

She projected returns on capital to average above 20% during the 10-year explicit forecast period and for operating margins to rise from 50% in 2014 to 52.5% in 2020, boosted by the launch of Tecfidera. The firm's broader neurology pipeline can provide additional sales growth and help diversify revenue.

"Overall, Biogen's top-line growth will average 5% during the next five years, and share-repurchase activity as well as operating leverage should enable the firm to achieve average earnings per share growth of 8% during this same period," said Andersen.

Celgene Corp.
Ticker CELG
Current yield -
Forward P/E 14.1
Price US$101.04
Fair value US$120
Data as of Mar. 9, 2016

Global biopharmaceutical company  Celgene (CELG) discovers, develops and markets therapeutic drugs designed to treat cancer and immunological diseases.

Owing to its long-term potential in new indications and markets, Celgene's blockbuster multiple myeloma therapy Revlimid remains at the core of the firm's potential for future revenue growth, said a Morningstar report, noting that the drug is poised to surpass US$11 billion in annual global sales in 2021.

"Between Revlimid and [a similar in-house product] Pomalyst, we expect Celgene to maintain a majority share of the multiple myeloma market, which continues to grow at a double-digit rate and could approach US$16 billion within five years," noted Andersen, who placed the stock's worth at US$120.

The firm's remaining portfolio, including arthritis drug Otezla projected to generate US$2.3 billion in sales by 2020, could help diversify its revenue base and reduce reliance on Revlimid as a growth driver, added Andersen.

"Celgene will experience average annual top-line growth of 16% and bottom-line growth of 20% during the five years ending in 2020," she said. "Given Revlimid's 95%-plus gross margin and opportunities for operating leverage, we see adjusted operating margins reaching 56% prior to Revlimid generic competition [arriving] in 2022."

The strength of the firm's pipeline further bolsters its competitive advantage, she added.

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About Author

Vikram Barhat

Vikram Barhat  Vikram Barhat is a Toronto-based financial writer specializing in investing, stock markets, personal finance and other areas of the financial services industry. He also writes for CNBC, BBC, The Globe and Mail, and Toronto Star.

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