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Stock Screen: Biotechnology Stocks With Strong Price Appreciation Potential - June 13, 2012
Biotechnology companies engage in the research, development, manufacturing, and distribution of products, services, and processes that involve modifying living organisms for specific human purposes in the fields of healthcare, pharmaceuticals, and agriculture, among others. Such processes include, but are not limited to, recombinant DNA technology (or cloning), molecular biology, genetic engineering, and gene therapy.
The research and development costs of bringing products and services to market are substantial, and there is no guarantee that a company will ultimately prove successful. Many times, current R&D spending and other operating costs at biotech firms can far outweigh the cash being generated from past efforts, and, therefore, quarterly losses are commonplace. In fact, of the 20 biotech names Value Line covers, only 50% recorded positive earnings in their latest reporting period.
These stocks are also known for their poor Earnings Predictability. Biotech investors are notoriously unforgiving of setbacks in the process of getting products or services to market. Even the slightest negative news can be severely punished, causing once high-flying stocks to trade at rock-bottom valuations. Despite the propensity for investors in this market to overreact, sometimes their responses to unfavorable developments are warranted, so it is always necessary to investigate developments thoroughly before investing. When good news does come about, investors pile in on aspirations of a promising product eventually yielding massive returns.
Due to the difficult-to-comprehend nature of biotech companies’ work, predicting their future success or failure can be difficult. Fortunately, there are some key characteristics to look for when analyzing these volatile equities.
One such measure is how many products the company currently has in the pipeline. Clearly, a company making a huge bet on one product is going to be far less stable than one that is older, more established, and already has proven products in the market.
Determining where funding originates is also important. If a biotech firm is small and has few cash reserves it can gain funding from a larger, more established healthcare partner firm or venture capital outfit. However, recently, more and more venture capital firms have curbed contributions in favor of more lucrative tech startups. Also, many large pharmaceutical companies facing their own financial difficulties have been choosing to reward their smaller biotech partners with funding as progress is made, instead of large up front lump sums.
In addition to cash reserves and funding opportunities, it is also important to consider a company’s debt load. Those firms with little indebtedness can more easily contend with cash burn while they make progress toward profitability.
Finally, it is important to consider how far along products are in the FDA approval process. Even if a product is in advanced stages, there is no guarantee that it will ultimately be approved, especially since the FDA has become more conservative and restrictive in recent years.
For this screen, we have chosen to focus on companies in the Biotechnology Industry with average projected price-appreciation potential in excess of 120% over the next three to five years. Of the 20 biotech names covered by Value Line, only five met this criterion, three of which are highlighted below. Indeed, long-term investors would be prudent to consider shares of Exelixis (EXEL), United Therapeutics (UTHR) and Xenoport, Inc. (XNPT).
Exelixis is a biotechnology company that focuses on the discovery and development of cancer therapies through the study of small molecules. The company’s proprietary model systems and genomic technologies address gene functions and the proteins they encode. Exelixis is also focused on other hard-to-treat medical conditions. The company collaborates with several big-name pharmaceutical organizations such as Bristol-Myers Squibb (BMY), GlaxoSmithKline (GSK) and Merck (MRK - Free Merck Stock Report).
Exelixis appears to be on the cusp of commercial success with the development of cabozantinib, a product candidate that inhibits the production of certain proteins that are conducive to cancer growth. At present, the compound is in Phase III trials to determine its scientific efficacy in the treatments of castrate-resistant prostate cancer and medullary thyroid cancer. The company is expected to file a new drug application with the FDA sometime in 2012.
Despite the absence of any commercialized products, EXEL has solid long-term growth prospects. Our sanguine outlook stems from the fact that the aforementioned Phase III trials are likely to gain regulatory approval by that time frame. Furthermore, current Phase II clinical trials are focused on extending the medical uses of cabozantinib to other areas such as metastatic lesions. Although EXEL derives research funding from aforementioned pharmaceutical heavy hitters, it is applying its own financial and research resources for cabo's development. Therefore, upon the likelihood of commercial success, investors that are prepared to accept the high risk/reward scenario, may be well rewarded.
United Therapeutics is a company that focuses on the development of therapies for patients with chronic, life-threatening diseases both in the United States and abroad. The company currently has three commercialized drugs on the market, Remodulin, Adcirca, and Tyvaso. All three drugs are used for the treatment of pulmonary arterial hypertension (PAH), a condition characterized by persistent high blood pressure in the pulmonary artery.
There are several bright spots for this company that makes its equity attractive both in the short and long terms. First, demand continues to increase for all three products currently in UTHR’s portfolio. Remodulin sales, (UTHR’s most mature product) have been enlivened recently by new patients being prescribed the drug. Furthermore, the therapy is being launched in several European countries and is expected to gain regulatory approval in Japan and China shortly. Demand for the other two therapies is increasing because they are relative newcomers to the market, having received FDA approval only in 2009. Both Adcirca and Tyvaso are being well received by patients and physicians alike, and we anticipate higher volumes for these therapies for the foreseeable future.
In addition, the company is on the threshold of adding a fourth product to its portfolio. It is currently conducting Phase III trials for the use of oral Remodulin , and has already achieved orphan drug status and a PDUFA (prescription drug user fee act) date of October of this year, which will expedite the regulatory process.
XenoPort is a biopharmaceutical company focused on the development and commercialization of therapies geared toward the cure of neurological diseases. The company utilizes natural nutrient transport mechanisms to enhance the benefits of orally administered compounds. At present, XenoPort has one FDA approved product, Horizant, which is used for the treatment of restless leg syndrome. Its research and development pipeline includes compounds that seek to discover treatments for other ailments such as Parkinson’s disease. XNPT collaborates with GlaxoSmithKline and Astellas for its R&D efforts.
The near-term picture for XenoPort seems marred with challenges. Its one commercialized product, Horizant, is facing weak demand from lower-than-expected patient adoption since the drug’s approval last year. Lack of demand has led to a dispute over a more effective marketing strategy with GlaxoSmithKline, which is XNPT’s collaborator on Horizant.
Despite such issues, the company’s longer-term prospects should enable it to reach profitability over the 3- to 5-year time frame. Demand hurdles will likely be ironed out by then. In addition, XNPT recently received regulatory approval for the drug in Japan, under the name Regnite. The company is collaborating with Astrellas in Japan for distribution. And the R&D pipeline has more to offer with several other Phase II and III trials underway, that may well be successful in adding to XenoPort’s portfolio. Better visibility of Horizant’s potential and the successful advancement of the R&D pipeline will be vital components that will facilitate profitability.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.