Looking ahead into 2021, the biotech sector is attractive from many perspectives.
Valuations are quite reasonable and earnings have steadily increased. The leading stocks in the sector have high-margins and above-average revenue growth. Finally, the total addressable market for effective treatments continues to expand.
Another catalyst for the sector is that due to the coronavirus, many countries are increasing spending on public health and upgrading their health infrastructure. Private-public partnerships like “Operation Warp Speed” seem to be working and have created a framework to incentivize and support companies who are developing therapies that could yield public health benefits.
Over the last five years, biotech valuations have gone from frothy to being cheaper than the S&P 500. In mid-2015, the IBB’s price to earnings ratio was around 90 at its peak. Today, it’s 20.2.
Since prices have been essentially flat, multiples compressed as earnings grew by 4.5 times over this period.
The 14-year, monthly chart above shows that from 2009 to 2015, the iShares Nasdaq Biotechnology ETF (IBB) gained 594%, which handily outperformed the S&P 500’s 220% gain over the same period.
At their peak in 2015, biotechs were getting frothy with elevated levels of call buying and huge gains in many speculative names. Valuations were also hitting extreme levels that led many prudent investors to steer clear from the sector.
Sometimes, these excesses are cleared out with a dramatic move lower that wipes out call-buyers and overleveraged traders. In biotech’s case, the excesses were cleared out with a multiyear period of range-bound trading.
Now, this quiet period looks to be ending. The bull market looks ready to resume as prices are consolidating near all-time highs, while fundamentals are much stronger than a few years ago.
While IBB is cheaper than the S&P 500, it’s projected to increase revenues between 7 and 12% over the next five years, while the S&P 500’s revenue growth is projected to be in the low single digits.
Additionally, due to the nature of the biotech business, margins are very high. For example, two of the largest components in IBB are Amgen (AMGN) and Gilead (GILD). Both have gross margins of around 76%.
Another sector with above-average growth and large margins is software. And, there are several similarities between the two sectors. In both, the most difficult and costly step is developing the product. However, once it’s proven to be effective, the marginal cost of achieving scale is minimal. This is a key factor in why software and biotech are great sectors for investors. And, it’s not a coincidence that both have been among the best-performers since 2009.
Another positive catalyst for biotechs is that drug development costs have significantly declined over the past decade due to advances in computer modeling and genomics. Many pharmaceutical companies also have barren pipelines in terms of new candidates for blockbuster drugs, so there’s likely to be an elevated amount of M&A for biotechs with promising prospects or encouraging early-stage results.
I believe that in 2021, biotechs are going to resume their role as market leaders. While buying a diversified ETF is one way to play this trend. Investors should also consider Intellia Therapeutics (NTLA), MannKind (MNKD), and Moderna (MRNA) as these stocks have significant upside.
MRNA has been in the news, as its vaccine trial was 94.5% effective in preventing coronavirus. The vaccine doesn’t require the same cold temperatures as Pfizer. And, the result also validates MRNA’s approach to using mRNA which could be a template for many new treatments.
Assuming that safety trials are completed with minimal complications, the MRNA vaccine’s distribution will be much simpler and easier than the Pfizer vaccine. Pfizer’s vaccine requires it to be stored in special refrigerators at – 80 degrees Celsius.
Moderna uses mRNA, which are pieces of DNA strands, to communicate with cells for them to increase the production of proteins to fight disease. Many believe that the application of mRNA will lead to treatments for all sorts of diseases with minimal side effects, as it’s essentially strengthening a person’s immune system.
MRNA is rated a Strong Buy. It has an “A” for Trade Grade, Buy & Hold Grade, and Peer Grade. Among Biotech stocks, it’s ranked #32 out of 384.
Intellia Therapeutics (NTLA)
NTLA’s focus is on gene editing. This path could allow for the development of treatments for diseases that were considered impossible to cure.
This is a new field, so the applications are primarily focused on understanding diseases at the DNA level to target them. However, many believe in the future, it will allow for custom-made medicine based on a person’s genome that would maximize effectiveness and minimize side-effects.
NTLA is one of the leading companies attempting to commercialize this scientific breakthrough. It currently has 10 potential treatments in its pipeline including ones to address sickle cell disease and hemophilia.
It’s important to note that NTLA’s products are either still in development or early-stage clinical trials. Additionally, it faces competition from other biotechs like CRSPR Therapeutics (CRSP) and Bluebird Bio (BLUE) who are working on treatments for similar diseases also with a similar approach.
Although there is some risk like any early-stage biotech, NTLA’s recent price action has been very strong. So far in November, the stock is up more than 30%, and it looks poised to make new, all-time highs by the end of the year.
The POWR Ratings are also bullish on the stock, as it’s rated a Strong Buy. It’s graded an “A” for Trade Grade, Buy & Hold Grade, and Peer Grade. Among Biotech stocks, it’s ranked #19 out of 384.
Following its IPO, MNKD’s stock was one of the hottest and most widely-followed biotech stocks due to the potential for its inhaled insulin product – Afrezza. The total market for insulin products is $25 billion annually, and diabetes is one of the fastest-growing diseases globally.
Being able to inhale insulin rather than inject it is a gamechanger for many people, especially kids and people with other types of ailments that are often associated with severe cases of diabetes.
Since the March lows, MNKD’s stock has tripled. The primary catalyst has been positive clinical data for Afrezza which showed that it’s as effective as injected insulin for patients with type-1 diabetes. Additionally, it helped with weight loss for people with type 2 diabetes. Such positive results could lead to more physicians prescribing the treatment for patients.
According to the POWR Ratings, MNKD is rated a Buy. It has an “A” for Trade Grade and Peer Grade. Among Biotechs, it’s ranked #27 out of 384.
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MRNA shares were trading at $96.48 per share on Monday morning, up $7.09 (+7.93%). Year-to-date, MRNA has gained 393.25%, versus a 14.05% rise in the benchmark S&P 500 index during the same period.
About the Author: Jaimini Desai
Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of POWR Growth newsletter. Learn more about Jaimini’s background, along with links to his most recent articles. More...
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