The strides in genomics and the focus on proteins indicate a period of increased growth and development in the biotech sector. But these stocks, along with the rest of the market, will probably make little progress in the next few months, according to Franklin M. Berger, vice-president and senior biotechnology analyst for JP Morgan Securities.
He discussed the sector in a Jan. 4 chat presented by Business Week Online on America Online. His comments came in response to questions from the audience and from Jack Dierdorff and Amey Stone of BW Online. Following are edited excerpts from the chat. A complete transcript of this chat is available from BW Online on AOL, keyword: BW Talk.
Q: How about some general market comment? How do you think the interest-rate cuts affect the market outlook?
A: Very interesting and important question.... Usually, I ask my crystal ball to tell me how things will look a year from now. This year, I'm asking my crystal ball to cut the year into two, because I think it's going to be dramatically different in the first half than in the second half of the year.
Usually, it's safe to say that biotech stocks are sunshine stocks -- they do well in a positive overall market environment. For that reason, I can't be too euphoric about the next three to six months.... I think the biotechnology revolution and valuations are going to form a foundation for a very powerful appreciation of the group over the next several years.
The fuel for this appreciation comes from several sources. First is the amount of new and practical biology that's being done.... Another key driver is the [pace of] clinical development has accelerated over the last two years.
Another factor is that in the last 24 months, nearly $60 billion has been given to the biotechnology industry to invest. And these dollars are going to their top projects, because this was a capital-starved industry. And lastly, the pharmaceutical industry is likely, in our view, to become a very strong partner and consumer of biotech output. The pharmaceutical industry has a wilting pipeline and very strong cash-flow growth. With consolidation in the industry, they have a big problem: How to keep earnings-per-share growth at 15% or better. They need the biotech industry more now than ever.
So these four reasons...place the biotech industry in a very strong position for growth and to deliver new drugs at a pace we've never seen before. To get back to our forecast, we think the next few months are going to require a correction in valuations, an end to momentum investing, and ultimately a return to more fundamental, traditional biotech investing.
Q: What large drug companies have some biotech in them?
A: Probably the pharmaceutical company which has the most biotech in it would be Eli Lilly & Co. (LLY). They've embraced the revolution in molecular biology with more enthusiasm than any other pharmaceutical company. Examples of that are Zovant [their new drug for sepsis], they're the largest manufacturer of insulin, they have a commitment to proteins, and we think they have one of the strongest commitments to gene screening in the pharmaceutical area.
Other companies that have a strong biotech aspect are Novartis (NVS), Roche, by virtue of its part-ownership of the Genentech pipeline, Schering-Plough (SGP), and American Home Products (AHP).
Q: Will biotech medications replace conventional medications?
A: The division between biotech drugs and old-fashioned pharmaceutical pills is starting to blur already. The biotech revolution started with injectable protein drugs.... But advances in cell biology are leading to the development of pills that are more effective than old-fashioned drugs discovered through serendipity.
So the biotech industry's output is changing as we understand diseases better. There's a very clear trend in the biotech industry toward small molecules. [An example is] OSI Pharmaceuticals (OSIP), which is working on a pill that interferes with the inner workings of cancer cells.
Q: Your thoughts, please, on Amgen (AMGN), Human Genome Sciences (HGSI), and Medarex (MEDX)?
A: We have a buy rating on Amgen because we have high expectations for their drug NESP, which is a more convenient form of EPO [which stimulates red-blood cell production]. EPO addresses approximately 500,000 patients on dialysis and a significant portion of over 2 million cancer patients.... The only caveat would be there is still an overhang regarding the outcome of patent litigation with Transkaryotic Therapies (TKTX)
.... Amgen is the largest biotechnology company and is a bellwether stock for the group, although we think that the finest combination of pipeline and revenue growth in the industry is Genentech (DNA).
Human Genome Sciences...has taken a single-minded approach to mapping the human genome as rapidly as possible. CEO William Haseltine has guided the company to patenting the genes for about 9,000 secreted proteins on the assumption that if the gene is expressed, he increases his chance of finding a useful therapeutic.... In the genomic space, this would be our top selection because of the vertical integration of the company and the exceptional focus on developing revenues quickly.
Medarex is a leader in developing human antibodies.... From an analyst's point of view, while the technologies at HGSI and Medarex are very powerful, revenue generation and profits are 5 to 10 years in the future. Their stocks are exceptionally volatile.
Q: Your opinion on Biogen (BGEN)?
A: Biogen has been one of the key names in the biotech space and has had exceptional success with their lead drug, Avonex [the primary treatment for multiple sclerosis]. That success has led to rapid revenue growth, high penetration rates, and sharp EPS growth. Regrettably, they're somewhat short in their pipeline, and we think that the stock's relatively flat performance reflects investors' concern that revenue growth will decline below 20% with no near-term drug to replace the prior growth from Avonex.
Q: We've had a couple of questions about PE Corp.-Celera Genomics (CRA). What's your view?
A: We don't formally cover Celera at JP Morgan. Celera clearly has changed the face of medicine and molecular biology with its rapid success in decoding the human genome. What has been missing is a clear route to profitability.... We think the company is taking steps in that direction, and we have a very high regard for the management and [their] vision. They're about to tackle the next frontier, which is a greater understanding of the protein interactions in the body.
Q: What are the most important medical breakthroughs that are just around the corner? And which stocks should investors get into now in hopes of getting in on the breakthroughs?
A: Genes make proteins, and proteins do the work in the body. So the next frontier is "proteomics" -- understanding the interactions between proteins and genes, tricking a cancer cell into committing suicide, and making a rapidly dividing carcinoma become a normal cell.
The old approaches to cancer relied essentially on poisoning the malignant cell faster than the surrounding normal cells. The new approaches...are becoming much more numerous as we [better] understand the biology of cancer. Companies in the forefront of the cancer battle include Genentech; Amgen, which recently licensed a new antibody; Celgene (CELG), which is working on several new classes of drug to starve tumors; and Lexicon Genetics (LEXG), which is doing basic research on the genetics of cancer.
There are about 40 companies researching very worthy new approaches to intervening in the chain of events that leads to cancer. [This year], we'll look for news from Imclone (IMCL)
regarding an antibody called C225 as well as more clinical data about Genentech's anti-VEGF antibody. Unfortunately, you ask a great question that requires about two days' worth of answers.
Q: How do you distinguish one proteomics company from another? Do you have a favorite?
A: The world of proteomics is exponentially larger than the world of genomics, so there's lots of space for several companies. We cover Large Scale Biology (LSBC) and recommend that. I already mentioned Celera. At the same time, we think there are many other worthy proteomics companies. We're aware of several new proteomics companies being formed privately, and we expect this to be one of the fastest-growing areas. Other important companies in the space are Oxford GlycoSciences and Myriad Genetics (MYGN).
Q: What about Biomira (BIOM)?
A: We don't cover Biomira, but there's something very important about Biomira's efforts that should be noted. They're [a leader] in the cancer vaccine area, which we hadn't talked about before. There's increasing evidence that cancer is a tough disease for two reasons: One is that it hides from the human immune system, and second, it has stealthy ways to disarm immune-system defenses. Therefore, devising new types of immune-system stimulants could pay rich dividends in fighting cancer.
Q: What percent of a portfolio should one have in biotech?
A: All biotech stocks are not created equal, so some biotech stocks will be far riskier than others. For example, Genentech is one of the most diversified companies in terms of revenue and product portfolio, while other companies are very dependent on the outcome of one trial or one drug. We think portfolio diversification is probably the No. 1 goal of any investor to prevent catastrophic depreciation.
That being said, we would adjust the relative weighting to biotech to represent an appropriate portion of a person's assets as measured by their retirement needs, their ability to reinvest, and their risk tolerance. So there's not a universal answer. This should be worked out with an experienced financial adviser.