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When it comes to biotech stocks, it's time to separate the signal from the noise.
It's been a rough year so far for the sector. The iShares Nasdaq Biotechnology ETF (Nasdaq: IBB) is down 12.7% from its peak in late January.
But that has less to do with the value of this sector and more to do with market overreactions to minor setbacks and rumors. As a result, some of the best biotech stocks on the market have been pushed well below their fundamental value based on assets and earnings.
And when you consider the breakout profit potential of some of these companies, the current prices look outrageously low.
So today, we're giving you three undervalued biotech picks, so you can capitalize on the market's blind spot... and one of them could easily soar more than 200%.
When you see why their shares are down, it's clear why it's created such a great buy-in point...
What the Market Gets Wrong About the Biotech Sector
Fears about patents running out, pipeline drugs being delayed, trade war implications, and pressures on high drug prices are among the factors driving biotech down right now.
But a drop in price is not always reflective of a company's health.
In March, for example, AbbVie Inc. (NYSE: ABBV) plunged 14% in two days after it revealed disappointing phase 2 results for Rova-T. It was one of more than 50 drugs in AbbVie's pipeline. But the market treated it like a deal-breaker.
"When it comes to biotech, Wall Street tends to overreact," says Money Morning Defense and Tech Specialist Michael Robinson. "Investors have been conditioned to punish the sector and its stocks whenever the opportunity presents itself."
It won't last.
Michael says three critical factors will drive the value of the industry as a whole:
- Aging America: The oldest of the 65 million American baby boomers have entered their 70s. The more this demographic enters old age, the more reliant we as a population will become on all kinds of pharmaceuticals developed by biotech firms.
- Buyout Bonanza: Mergers and acquisitions in the healthcare sector surged 27%, to $332 billion, in 2017. Analysts at Bain & Co. expect that rising trend to continue in 2018. We've already seen $47 billion in M&A activity in the biotech sector in the first quarter of this year, 16% higher than the same quarter in 2017. And more big deals appear to be on the way, as we'll discuss further down.
- Better Politics: Though investors have anxiety over political pressure on drug companies, it appears to be unwarranted. In fact, the most significant move from Washington affecting biotech firms has been the speeding up of the FDA approval process. That's only going to be a positive for the industry.
"The biotech industry is clearly headed for better days," says Michael. "Not just in 2018, but well into the next decade."
With that in mind, we've selected three standout biotech stocks ready to pop.
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All three of these stocks are growing earnings with remarkable consistency. They're trading well below their market value. And each one of them has earned a top score on our Money Morning Stock VQScore™ system, indicating they are giving us an excellent point to buy in.
Undervalued Biotech Stocks, No. 3
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Dublin-based Shire Plc. (Nasdaq: SHPG) is a global leader in treating rare diseases and other specialized disorders. Its blockbuster ADHD treatment, Vyvanse, brought in more than $2 billion globally in 2017.
Shire's treatments for hemophilia generated nearly $3 billion in sales, and its treatments for the skin disease angioedema generated over $1.4 billion.
The hemophilia treatment is one of the reasons Shire stock has fallen 9.7% over the last 12 months. Rival drugmaker Roche has developed a new drug, Helimbra, to compete in the $11 billion hemophilia drug market.
But anxiety over Roche's new drug appears to be overblown. In November, the FDA slapped it with a black box warning - the most serious possible - due to the risk of blood clots.
Shire can withstand a little competition anyway. It's got 40 drugs in its pipeline, with 22 of those in phase 3 trials or the registration stage.
That pipeline got a boost when Shire purchased Baxalta, which specializes in hematology, immunology, and oncology, in 2016.
Shire expects to use the Baxalta deal to cut costs by $700 million by 2019.
Despite all those developments, the market seems utterly confused about what to make of the stock. Over the last 12 months, it has ranged from $123 to $192 - a 36% variation. It now stands around $158, with no clear momentum in either direction.
But the numbers suggest that will change soon.
At 10.4, SHPG's forward P/E ratio is well below the average for major pharma stocks of 14.51. If we adjusted that ratio to match its competitors, the stock would be at $221, or 39.5% higher than it is today. The trailing P/E ratio, similarly, is 21.2% below the industry average of 14.43.
Despite the disappointing stock performance, SHPG boosted sales by 35% from the year before and 139% from 2015. Earnings per share (EPS) rose for the seventh consecutive year. That trend is on pace to continue, as Shire beat EPS expectations by 8% in Q1 2018.
While the market hasn't noticed this strong performance, Wall Street analysts have. Among 12 analysts, the consensus target price for SHPG is $197.50 in the next 12 months. That would represent a 24% rise from its current level. We think that's conservative.
"This may very well be the least understood Big Pharma firm out there right now," said Michael in January. That could be why it's become a takeover target for Japan's Takeda Pharmaceutical Co. (OTCMKTS: TKPYY), which right now is offering $64 billion (about 36% higher than its current market price) to acquire Shire.
That's still a small price for the competitive edge Takeda would get. And the move would bolster SHPG shareholders' profits in the process.
Undervalued Biotech Stocks, No. 2
Jazz Pharmaceuticals Plc. (Nasdaq: JAZZ) is about a fifth of Shire's size, with a market cap around $9 billion. But it's another biotech out of Ireland that's been knocked around over the last year. Though it has bounced up 15% over the last four months, JAZZ is still down 5% overall since last May.
Also like Shire, this stock is a better bet than the market realizes.
Jazz currently has six drugs on the market, including Xyrem, a narcolepsy drug with annual sales that crossed the $1 billion mark two years ago and were up to $1.2 billion in 2017. Sales of Defitelio, for the treatment of hepatic VOD, also known as sinusoidal obstruction syndrome (SOS), increased 23% from the year earlier and 88% over the past two years.
While Xyrem has made up the bulk of Jazz's sales so far, last year, Vyxeos became the first FDA-approved therapy for the treatment of certain types of acute myeloid leukemia (AML). RBC Capital Markets analyst Randall Stanicky expects global sales for Vyxeos to rise nearly tenfold, to $235 million, in the next four years.
Jazz also has 17 drugs in its pipeline, of which four are in phase 3 trials, and three have cleared trials and are on the way to approval.
EPS have risen every year since 2010 and have multiplied sevenfold in that time. According to FactSet, Jazz is expected to boost EPS another 83% by 2021.
That's impressive, even before you consider the stock is undervalued. Its forward PEG ratio - a measure by which a fairly priced stock should score a 1 - is just 0.2.
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Nearly every analyst values this company above its market price. FactSet reports 16 out of 19 analysts rate JAZZ a "Buy," with an average target price of $181 - 19% higher than its current price.
With Jazz Pharmaceuticals, you get a stock that is underpriced for its past performance, projected to keep growing at an impressive pace, and could pop at any moment, when one of its newer therapies takes off.
Undervalued Biotech Stocks, No. 1
New Jersey-based Celgene Corp. (Nasdaq: CELG) took a market hit back in October, dropping over 30% for the month thanks to lowered guidance. Between the unease in the stock market in general and the pressure on biotech stocks in particular, Celgene has yet to recover.
But don't be fooled by Wall Street's fear: This company is on solid footing.
There are three signs of strength we want to see from a biotech company, and Celgene has all of them.
- A solid portfolio: Celgene's Revlimid is a top treatment for multiple myeloma, bringing in $8 billion in sales in 2017, making it the No. 2 bestselling drug in the world. On top of that, a new usage for the company's next biggest earner, Pomalyst, could pave the way for even higher sales after the company announced positive results from a phase 3 trial in February.
- Long-term patents: The company's top sellers are protected well into the 2020s, ensuring continued strong sales for years to come.
- A strong pipeline: Lost on the investors who bailed on Celgene is its robust pipeline. That includes Fedratinib, a treatment for myelofibrosis, which the company will likely submit for FDA approval in the next few months. Celgene has also established more than a dozen partnerships to bring new blockbuster drugs to market.
Celgene got some bad publicity in February, when it was announced that the company would have to correct issues in its application for FDA approval of Ozanimod, a treatment for multiple sclerosis, which was on pace for approval this year. The stock dropped lower this week, when Morgan Stanley suggested the setback could hold up the drug's approval by up to three years.
It's a classic example of Wall Street overreaction.
Analyst Sam Sayid at Mizuho Bank suggested the FDA's decision appeared to be due to an overabundance of caution relating to dosage amounts, and the more likely time frame for successful resubmission is within the next year.
The market's nail-biting over lowered guidance and pipeline delays has created incredible value. Its recent drop has brought the share price down to a mere 9.6 times forward earnings, compared to a biotech industry average of 38.53. Even if Celgene's ratio came up to just half that of the rest of the industry, that would mean a 100% gain for the stock. Reaching the industry average would result in a gain of more than 200%.
Celgene's earnings date is coming up May 4. Despite the negative press, the company's financials have been consistently solid. It has increased its EPS every year since 2010 and is expected to grow 16.7% from the same quarter last year. But Celgene has beat expectations in eight straight quarters, and no one should be surprised if it does it again.
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About the Author
Stephen Mack has been writing about economics and finance since 2011. He contributed material for the best-selling books Aftershock and The Aftershock Investor. He lives in Baltimore, Maryland.