Four Biotechs to Buy Now

Elections can be hard on stocks. In the heat of the campaign, politicians often make promises and seek to assure voters they share many of the same problems that make life difficult for voters. At times, when trying to reassure voters, politicians seem to demonize industries. Financial stocks were a popular demon after the financial crisis. This year, drug makers became demons and targets of a few politicians in their speeches and tweets.

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  • To be fair, the CEOs of drug companies made easy targets this year.

    In February, Martin Shkreli, a 30-something hedge-fund manager turned pharmaceutical-company CEO, was indicted on securities fraud charges. Vanity Fair noted at the time, “Even before his arrest this week on securities fraud allegations, Wall Street’s most visible villain was infamous for gouging AIDS patients and pregnant women, buying a very overpriced Wu-Tang Clan album, and trolling the world on Twitter.” Shkreli shot to fame in 2015 when his company acquired the rights to a lifesaving drug and promptly boosted its price over 5,000%, from $13.50 a tablet to $750. His defense, “The attempt to public shame is interesting because everything we’ve done is legal. [Standard Oil tycoon John D.] Rockefeller made no attempt to apologize as long as what he was doing was legal,” only made things worse. He also said he wished he had raised the price higher because “my investors expect me to maximize profits.”

    With that setup in an election year, the stage was set and politicians were on the hunt for the next Shkreli.

    Traders seemed to understand this news wouldn’t be bullish for the sector and have been selling biotechs for most of the past year. iShares Nasdaq Biotechnology (Nasdaq: IBB), a proxy for the sector, is down more than 25% since the beginning of the year, while the broad stock market is little changed.

    The most recent down leg in IBB came as politicians spotted a villain. Epipen maker Mylan (Nasdaq: MYL) took a turn in the headlines addressing concerns that its lifesaving product cost more than $600, up from just $100 in 2007.

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  • Based on history, now could be the time for biotechs to bottom. Typically, after an election, politicians are unable to fully deliver on their promises. They become distracted by crises no one anticipated during the election and the reality of governing limits what they can actually do since Congress must agree with proposed changes. In the end, legislation is often significantly less harmful to an industry than the rhetoric promised on the campaign trail.

    We scanned for biotechs with strong cash flow and promising stock market patterns. We found four that could deliver market-beating gains in a sector rebound.

    Aratana Therapeutics, Inc. (Nasdaq: PETX) develops safe and effective therapeutics for pets by combining human drug development opportunities with veterinary medicine. PETX focuses its efforts in the areas of osteoarthritis, post-operative pain management, inappetence, allergy, lymphoma and osteosarcoma, viral diseases and other unmet pet health needs. Pet medicines are an estimated $8 billion to $10 billion a year market and some of the biggest human-drug companies, including Pfizer, have more than $1 billion in sales in the market.

    Even though it serves pets, PETX is lumped into the biotech sector and its financials look like a typical startup biotech company. PETX has low sales, a history of losses and forecasts of additional losses. But, also like many biotechs, it has promising technology and even though sales are low, they are growing rapidly.

    The U.S. Food and Drug Administration’s Center for Veterinary Medicine recently approved Artana’s painkiller, Nocita, as a local post-operative analgesia for cranial cruciate ligament surgery in dogs. The approval came in August and sales are expected to reach $40 million this year. Nocita is a long-acting, local anesthetic that provides relief for up to 72 hours after surgery. For now, the approved use is rather narrow. The drug could be useful in other applications and that could lead to increased sales.

    The stock began trading in June 2013 and appears to have formed a basing pattern before pulling back in the last month.

    The pullback appears to be a buying opportunity with momentum, shown as the stochastics indicator at the bottom of the chart, remaining bullish.

    Exelixis, Inc. (Nasdaq: EXEL) is a biopharmaceutical company that develops and commercializes small molecule therapies with the potential to improve the treatment of cancer. EXEL has three internally developed medications that have received regulatory approval to treat various types of cancer. Small molecule drugs can generally be delivered in pill form while large molecule drugs usually need to be injected. This makes small molecule drugs less expensive to deliver and gives them a potential edge in the market place.

    Analysts expect EXEL to turn profitable in 2018 as its loss narrows from $0.56 a share this year to $0.05 next year. Sales are expected to grow rapidly over that time from $37 million last year to $156 million this year and more than $300 million in 2017. This is the typical path for a successful biotech company. Biotechs have traded with an average price-to-sales (P/S) ratio of 8.8 over the past five years implying a 12-month price target of almost $16 a share for EXEL.

    Exact Sciences Corporation (Nasdaq: EXAS) developed Cologuard, the first noninvasive screening test for colorectal cancer that analyzes both stool DNA and blood biomarkers. Cologuard offers an alternative to colonoscopies in some cases and are preferable to patients in most cases. According to company research, Cologuard identified 92% of cancers and 69% of the most advanced precancerous polyps in average risk patients. This makes it suitable for some low-risk patients.

    Sales are expected to grow rapidly and losses are narrowing. EXAS is an early stage growth story and it is a true “story stock” with a simple explanation for why the price should go up.

    Colon cancer kills nearly 50,000 Americans a year and early detection could save lives. The Centers for Disease Control and Prevention estimates just 58% of at-risk individuals are screened today. Analysts note that if screening rates improve and insurers continue to cover Cologuard, EXAS could test up to 30% of an estimated market size of 80 million Americans. If the company can capture even 10% of that market, once every three-year screening would result in more than 2.5 million tests a year. At an average selling price of $400, that’s about $1 billion in annual sales. This year, management believes it will complete 240,000 tests, up from 104,000 in 2015. If test volume continues to grow at this pace, EXAS could be worth two or three times its current price.

    Depomed, Inc. (Nasdaq: DEPO) is a specialty pharmaceutical company focused on products to treat pain and other central nervous system (CNS) conditions. The company markets FDA approved products such as, NUCYNTA ER, NUCYNTA, Gralise, Cambia, Lazanda, and Zipsor. DEPO also acquired and is developing a drug called cebranopadol, for the treatment of moderate to severe chronic nociceptive and neuropathic pain.

    The activist hedge fund Starboard Value is pushing DEPO to unlock shareholder value. Starboard was a driving force behind Yahoo’s sale to Verizon but the fund became famous for its investment in the parent company of the Olive Garden restaurants. Starboard’s presentation to Darden Restaurants shows that Olive Garden was serving customers too many of its unlimited breadsticks and not following company policies that could increase sales and customer satisfaction. There were other reasons for its investment but that one generated headlines. Now, they are targeting DEPO with that level of attention.

    These four stocks could be among the winners when biotech rebounds. That rebound could begin soon as the noise of the election subsides.

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