|JP Morgan Strategist Says Give Biotech A Look
On analyst believes now is the time for investors to head back to the downtrodden biotechnology sector.
28 Oct 2002
CHICAGO -(Dow Jones)- J.P. Morgan's Jack Caffrey concedes that he's a strategist, not a biotech analyst.
That said, he believes now is the time for investors to head back to the downtrodden biotechnology sector.
Caffrey, vice president and equity strategist for private clients at J.P. Morgan, recently helped set up an investment vehicle for private investors tracking the Nasdaq Biotechnology Index (NBI), which follows about 75 biotech companies.
Over the summer, Caffrey and his associates looked at a number of sectors, trying to find one that could do well despite the sluggish U.S. economy. He thinks he's found one with biotech.
"Biotech made the most sense," Caffrey said in a recent telephone interview. "It offered the most bang for the buck."
Valuation Is Attractive
Not being a biotech analyst, Caffrey is more interested in discussing the broader picture rather than specific companies or drugs.
He sees a variety of factors coming together over the next weeks and months that make biotech a good place to be.
First, he said, valuations are relatively attractive. Over the last decade or so, the price-to-sales ratio for biotech companies he tracks has been around 11.
After this year's 45% year-to-date loss in the NBI, the price-to-sales ratio stands at about 10. During the peak of past booms, he noted, that ratio has risen to as high as 20.
That was the case as recently as mid-2001, when the NBI shot briefly above 1000 (It's now at 507.47).
"There was dramatic interest in decoding the genome, and a sense that it would profoundly change medicine," Caffrey said.
"Now there's the realization that it's an important scientific step, but that drugs won't come immediately from it. It will take 10 to 12 years to demonstrate convincingly that this science is implementable, rather than a neat lab experiment."
All the selling over the last year means there's fewer people out there with shares left to sell and more diehards, making it hard for the market to sink much lower, J.P. Morgan strategists said.
With only a core of dedicated, long-term investors remaining, they said, selling pressure on the biotech sector could well have abated.
"Valuations aren't cheap, but they're reasonable," Caffrey said.
There are plenty of good reasons to buy besides valuation and the potential of a market bottom, Caffrey said.
He noted that the sector has a "very robust pipeline," with more than 350 drugs and vaccines targeting more than 200 diseases in the clinical testing stage.
Some of these drugs are what Caffrey calls "orphan drugs," meaning they target rare diseases that affect only a small number of people.
Compared with the millions of patients served by drugs manufactured by the big pharmaceutical companies, this could look like a liability on paper, Caffrey said. But actually, it can be a strength.
"Orphan" Drugs May Find A Home
"Orphan drugs are potentially very lucrative despite the low population," Caffrey said.
He cited Fabry Disease, a fat storage disorder caused by a gene alteration that puts patients at greater risk for strokes, heart attacks and kidney damage. Genzyme Corp. (GENZ) is studying possible treatments for the illness.
The attraction of a market like this, Caffrey said, is that while just a few thousand people suffer from the disease, treatment could cost $150,000 a year for each patient.
Also, if a drug goes through trials and looks like it can be effective, it will probably receive an expedited review from the U.S. Food and Drug Agency to get it quickly onto the market.
"No one will balk" at the price of treatment, Caffrey said, because the disease was previously untreatable.
Another attraction for biotech drugs is longer term, he noted. While typical pharmaceutical firms face immediate generic competition when their patents expire, it's harder for a generic drug firm to manufacture a biotech drug that mimics the first one, simply because the science is cell-based, making it difficult to copy.
That could mean less generic competition when biotech drug patents expire.
He also sees less "me-too" syndrome in the biotech industry, where one company tries to follow in the footsteps of another with a major new drug for a certain illness.
He noted the competition among pharmaceutical companies marketing competing cholesterol drugs.
Biotech also enjoys a demographic advantage over many other sectors, though the same could be said for the health-care sector as a whole.
The number of people in the U.S. aged 65 and older is growing quickly, and the average person that age has 11 prescriptions a year, Caffrey said.
Faster Approval By FDA
For a long time, regulatory concerns dogged the entire health care market, but that may be changing.
The U.S. Senate's relatively quick recent confirmation of Dr. Mark McClellan to lead the FDA is a sign of hope, Caffrey said, that approval times for new drugs will grow shorter.
The FDA has been without a head since early last year, and McClellan is expected to take office soon.
"A number of people say that having no one in charge led to drift and made the approval process slower and more risk averse," Caffrey said.
"With someone in charge, it will allow the FDA to do its mandate and clear up the approval process logjam. And it's a key catalyst for biotech because there's so much more in the pipeline."
Caffrey also pointed out that between now and next spring, there are more than 15 large industry conferences scheduled, which should keep the focus on new drugs and research and stimulate investor interest.
He sees signs that already, the biotech picture is changing for the better. The NBI, through midday Monday, has risen 20% from its mid-July low.
That performance slightly outpaces that of the S&P 500 Index. That, along with the quick approval of McClellan to lead the FDA, reassures him that he's on the right track.
Caffrey hesitates to make predictions. He won't, for instance, forecast exactly where he thinks the NBI will go from here. But he's relatively certain that the biotech market is in for a good stretch.
"If the science comes through, I see significant appreciation," McClellan said.
The top of the run could come when sector prices once again trade at 20 times sales. "When you get to 20 times sales, that seems to be a barrier to the upside for the sector," he said.