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Biotech is in “a Category 5 storm, as is energy in 2020” – why dissenters say the sector is a buy

If you want to know how much investors hate the biotech sector right now, look at this simple statistic: More than 25% of small biotech companies have a market capitalization less than they have in cash.

“The market is saying that a quarter of these companies are literally worth nothing,” said Jefferies biotech analyst Michael Yee, who recently published the finding.

That’s remarkable. That 25% is the highest in 15 years – higher than even during the agonizingly long bear market of the 2008 financial crisis.

At the time, 18% was trading below cash. From 2010 to 2020, the number increased between 3% and 11%, according to Yee and his team. It refers to small and mid-cap companies with a market capitalization of less than $5 billion. These are the ones who typically have no income and have early-stage therapies in trials.

“This is the worst loss we’ve had in our careers,” says biotech analyst Charmaine Chan of the Cambiar Opportunity Fund CAMOX.
+0.04%.
“No one has seen anything worse unless they have done so for over 20 years.”

For contraries, this type of extreme signal only suggests one thing. The sector is a buy. While it’s hard to find biotech pundits optimistic about the group (even Yee is cautious), I’m not the only one who sees this as a contrarian opportunity.

Category 5 biotechnology storm

Macro analyst Larry McDonald of The Bear Traps Report takes a similar view. To spot contrarian buy signals, McDonald tracks a collection of surrender markers he developed during the 2008 crisis. They tell him when a sector is so despised that it’s worth buying, on the contrary. It’s a “blood in the streets” indicator, to borrow the old Wall Street adage that says we should buy stocks when there’s blood in the streets. His surrender indicator tracks several technical signals, among other things.

“The biotech surrender model is a Category 5 storm, just like energy in 2020,” says McDonald. “The risk/reward ratio is fantastic, at least for a bucking bounce.”

Check out how the SPDR S&P Oil & Gas Exploration & Production Exchange Traded Fund XOP,
+0.60%
up over 170% from the 2020 median.

McDonald proposes the SPDR S&P Biotech XBI,
+1.34%
and iShares Biotechnology IBB,
+0.50%
ETFs. I propose six individual stocks below, with the help of Yee and Chan. McDonald thinks the XBI could rise 20% to $83 in a shorter-term countertrend rally and potentially rise 30% to $90 or more in a year. These targets are the 50 and 100 day moving averages.

Biotech experts disagree

People who know the space better than me and McDonald are not on board. Yee, who has been cautious on the big drop since last summer, believes biotechnology will remain challenged for the year. “It will take a long time to heal these wounds,” he says.

There’s nothing broken about the underlying science being developed in biotechnology or the prospects for innovation, he says. It’s just that stocks can stay cheap longer than you expect. “Why would anyone wake up tomorrow and say, ‘I have to buy all the small-cap biotech stocks down 50%?’ It’s always hard to be the first in the swamp.”

“I think it’s a little early to be optimistic,” agrees Cambiar’s Chan. “You need catalysts to change the narrative.”

Watch for progress on these fronts.

1. More biotech mergers and acquisitions

“M&A would change the narrative, but it’s not happening,” says Chan.

There is a good reason for this, however. “Big Pharma has so much money that they could basically buy the entire Smidcap universe,” Yee notes. Their cumulative cash balance has now grown to over $300 billion.

“Big pharma CFOs look at this carnage and lick their lips,” says McDonald. “You’re likely to see a lot more transactions down here.”

Yee expects M&A to pick up gradually but is less optimistic than McDonald. “M&A is difficult when markets are falling fast,” he says.

2. The FDA gets their act together

From baby formula shortages to drug approval delays and terribly mixed signals on regulatory pathways, the Food & Drug Administration has been a huge source of trouble and confusion for everyone from parents to biotech investors. “The FDA has become more unpredictable,” says Chan.

OK, there was the distraction of the pandemic and the need to focus on vaccines and therapies. But now that COVID-19 is (hopefully) abating, perhaps the FDA can refocus on approving drugs.

3. General market conditions are improving

Investors continue to panic about inflation and recession, knowing that the Fed can’t come to the rescue with the proverbial “Fed put” (stimulating stock market declines).

Since the Fed took away the training wheels from investors, they have had to think through inflation and GDP growth for themselves. So far they are doing a poor job as inflation has obviously peaked and we are not going into a recession. Hopefully they’ll be up to the task soon.

Stocks to consider…or avoid

Chan highlights UCB UCBJY,
-2.34%

UCB,
-1.85%,
a Belgian biotech company. Its stock was hit hard in mid-May when the FDA denied its application for approval of its bimekizumab therapy to treat a chronic inflammatory condition called plaque psoriasis over some manufacturing inspection issues.

Now it has to be reapplied, but the data supporting bimekizumab seems solid. It has already been approved in Europe, Japan, Canada and Australia.

She also likes the prospects for two other UCB therapies in late-stage trials for neurological disorders: Zilucoplan and rozanolixizumab. Expect more data reads and regulatory filings in the second half of this year, possible catalysts.

Yee Highlights Vertex Pharmaceuticals VRTX,
+1.23%,
Fate Therapeutics DESTINY,
+3.13%
and Ventyx Biosciences VTYX,
+2.84%.

Vertex saw strong sales growth for its cystic fibrosis drug Trikafta (up 48% in the first quarter to $1.76 billion). It is also showing good progress on pipeline therapies for cystic fibrosis, sickle cell disease, kidney disease, diabetes and pain. The stock is down 14% from April highs of $292.75.

Fate Therapeutics shares are down 77% since August despite no negative developments, Yee says. Fate continues to show progress in the development of its natural killer cell immunotherapies for cancer. Destiny doesn’t have to raise capital any time soon. It has a partnership with Johnson & Johnson JNJ,
+1.75%
to develop cancer therapies.

Ventyx Biosciences develops therapies for inflammatory diseases such as psoriasis, arthritis, Crohn’s disease and colitis. It expects key Phase I study data on two of them in the next four months.

The companies trade “for free”

Yee warns against believing that companies trading below cash could be bought out just because their science can technically be acquired for free. “They probably suffered from negative events,” he says. But he has buy recommendations for Olema Pharmaceuticals OLMA,
-1.74%,
which has approximately $7 per share in cash versus a current stock price of $2.10, and LianBio LIAN,
-1.20%
($3.76 cash versus $2.47 stock price).

Olema conducts early-stage breast cancer therapy studies. LianBio helps partners study and develop their therapies in China. It has a deal with Bristol-Myers Squibb BMY,
+0.30%,
for example, to develop a cardiovascular therapy there called Mavacamten, which is approved in the United States. Yee believes that China approach alone is worth $13 a share for LianBio. It works with other companies to develop therapies for inflammation, respiratory and eye diseases.

“We recognize that sentiment for Chinese equities could remain challenging, but the company has ample cash to execute in the pipeline and in ongoing studies, including lead asset Mavacamten,” Yee said.

Note that these are tiny companies with market caps below $300 million and can be quite risky in biotechnology.

vaccine supplies

moderna mRNA,
-4.97%,
Pfizer PFE,
+3.59%
and Novavax NVAX,
-8.57%
are far from the heights seen in the midst of the pandemic. But Yee warns against getting too optimistic. The reason: The pandemic seems to be declining, and major vaccine buyers around the world have decided against purchasing options and postponed deliveries.

Michael Brush is a columnist for MarketWatch. He owns VRTX and FATE and has proposed VRTX, FATE, PFE, NVAX and OLMA in his stock newsletter. polish stocks. Follow him on Twitter @mbrushstocks.

https://www.marketwatch.com/story/the-capitulation-model-for-biotech-is-a-category-5-storm-the-same-as-energy-in-2020-why-contrarians-say-the-sector-is-a-buy-11653057284?rss=1&siteid=rss Biotech is in “a Category 5 storm, as is energy in 2020” – why dissenters say the sector is a buy

Brian Lowry

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