Biotech Sector Continues to Outperform

Whereas yesterday we addressed the difficulties within the Big Pharma market, today we look at its smaller cousin, biotech. Zacks senior biotech analyst Grant Zeng, CFA was on hand to give us his perspective recently.

With another earnings season passing, do you expect 2008 will be a strong year for biotech stocks?

Yes, I am still positive for the whole biotech industry for 2008. If you look at the performance of NASDAQ biotech index so far this year, you will see the biotech sector has outperformed the market.

I am confident the biotech sector as a whole will continue to outperform the broad market index in the remainder of this year. I believe the biotech industry is likely less affected by the slowdown of the US economy than other sectors. The driving force behind the growth is the high need for quality, innovative medicines. The US and global healthcare spending will continue to grow dramatically due to demographic change and high economic growth in this emerging market.

Were there any surprises this quarter from companies in your coverage?

During this quarter, some companies surprised me in either total revenue or earnings per share. Some surprised me with specific product sales.

One example is Celgene (CELG). Net product sales in 1Q08 were $417.6 million, higher than our estimate of $409.7 million. Total revenue in 1Q08 was $448.8 million, versus our estimate of $434.4 million. Adjusted earnings per share [EPS] were $0.29, versus our estimate of $0.28 per share. Much of the surprise came from sales of the company’s key product Revlimid. 1Q08 sales of Revlimid were $286.8 million, $6.8 million higher than our estimate of $280 million.

Another positive example is Regeneron (REGN). In 1Q08, total revenue was $56.4 million, way higher than our estimate of $35 million. Actual loss per share in 1Q08 was -$0.15 versus our estimate of -$0.21 per share. Myriad Genetics (MYGN) also surprised me with higher 1Q08 predictive medicine sales ($59 million versus our estimate of $58.5 million).

On the negative side, Alkermes (ALKS) surprised me with less than expected total revenue. In fiscal 4Q08 ended March 2008, total revenue came in at $62.4 million, $10.1 million short of our estimate of $72.5 million. Another negative example is Trimeris (TRMS). Total revenue in the 1Q08 was $42.7 million, way lower than our estimate of $66 million. The shortage is mainly due to lackluster sales of its product Fuzeon, which was $17 million, versus our estimate of $28.5 million.

Which sub-sector of the biotech industry has the brightest outlook at this time?

It’s hard to say which one sub-sector has the brightest outlook at this point of time. But we see great potential for molecular diagnostics. The diagnostics market has enjoyed a high growth in the past few years and we believe the sector will continue to grow at a high rate in the next few years thank to the breakthrough in genomics and proteomics. Also, personalized medicine has gained favor in the past few years and the trend will continue in the future. Diagnostics is a lucrative business and is less risky than therapeutic programs.

If you had to name your top two or three Buy recommendations, which stocks would they be?

My top three picks of biotech companies are BioMarin Pharmaceuticals Inc. (BMRN), Myriad Genetics and Regeneron.

We recommended BMRN in early August 2005 when its stock price was about $8 per share. We have been bullish about this stock ever since. Currently the stock trades at about $38 per share and we are still optimistic and expect further price appreciation. Our price target is $45 per share. BMRN develops therapeutics for genetic disorders and has three products on the market. The company has a decent pipeline and very strong cash position. Profitability is on track with an estimated EPS of $0.13 for 2008.

We recommended MYGN in early Feb 2006 at about $22 per share. We have been bullish about this stock ever since and current price is $49 per share. We are still bullish about this stock and our price target is $56 per share. MYGN has a different business model compared to that of BMRN. MYGN operates in two different segments: predictive medicine and therapeutics. Predictive medicine has been performing very well and has provided cash for its therapeutic programs. MYGN also has a decent pipeline and a very strong cash position. The company just signed a good deal with Lundbeck A/S to market its phase III Alzheimer’s candidate Flurizan in Europe.

We upgraded REGN in early November 2006 at about $22 per share. The stock price has been very volatile in the past year which is typical of a biotech company. Our buy call is based on the strong fundamentals of the company: decent pipeline with many late stage product candidates targeting large markets, and strong cash position for long term growth strategy. The company’s unique platform technology has attracted big pharmaceutical companies such as Bayer Healthcare (BAY) and Sanofi-Aventis (SNY) for partnerships. The company also has a FDA approved product on the market. We believe the company has potential for long term investors and our price target is $28 per share.

Are there any companies or segments of biotech you would recommend investors stay away from in the near term?

We are currently negative on the inhaled insulin segment. Therefore, we have a Sell rating on Mannkind Corporation (MNKD), which develops inhaled insulin.

The inhaled insulin program was once thought to be the garden of blockbusters for diabetes treatment. But things all changed since October 2007 when Pfizer (PFE) withdrew its marketing support of Exubera, the first FDA-approved inhaled insulin on the market.

Following the withdrawal of marketing support of Exubera from Pfizer, Novo Nordisk (NVO)/Aradigm (ARDM.OB) and Eli Lilly (LLY)/Alkermes discontinued their late stage inhaled insulin programs respectively in early 2008. The reason for the withdrawal or discontinuation is apparently the lack of market prospectus for inhaled insulin products which has been evidenced by the very slow uptake of Exubera sales (only $12 million in the first three quarters of 2007). Another reason is the potential risk for lung cancer of inhaled insulin products.

We have a Sell rating on Mannkind based on our general negative view on the inhaled insulin segment. MNKD relies heavily on inhaled insulin program with a very weak pipeline. Also, the company is burning cash at too high a rate and cash position is a matter of great concern.

Grant Zeng, CFA is a senior analyst covering the biotechnology industry for Zacks Equity Research.