Biotech and pharmaceutical stocks have been in the political crosshairs for more than a year. The threat of government controls left the group attractively valued into 2017 but the potential for headline risks has kept most investors on the sidelines. 

That is, until last week.

Biotech shares jumped last week on rumors of the President’s executive order supporting industry-friendly measures that address drug prices. Prices were also boosted by the industry escaping targeted pricing measures in the Senate’s draft healthcare bill.

With the headline risk of regulatory action against pricing all but off the table, shares of drug makers can finally get back to trading at fair values. 

While investors have already started to come back to the group, the market still isn’t fully pricing in leadership or drug pipeline potential. 

Biotech Steps Up To Lead The Market
The Biotech industry got hammered last year, with several companies spotlighted for triple-digit price increases on drugs and non-stop rhetoric against the industry from both sides of the race for president. 

#-ad_banner-#Shares of the SPDR S&P Biotech ETF (NYSE: XBI) plunged 25%, even with the late-year rally after the November election. Investors have been cautiously optimistic this year, noting low valuations but staying largely on the sidelines.

Those risks have caused the group to fall hard on more than one occasion, and some individual names have suffered double-digit setbacks.

Biotech investors got a rude awakening when President Trump used his first news conference on January 11th to call out drug makers, saying they were, “getting away with murder.” The news sent the biotech group lower by as much as 4.5% on that day alone.

Industry and investor fears over greater government participation or control of drug prices returned when the President tweeted in March that he was working on a new system to increase competition and bring prices down.

But the more healthcare reform develops in Washington, the more investors start to open up to valuations and upside potential.

A leaked draft of the President’s executive order targeting the industry and developments in Congress around a new healthcare bill sent biotech stocks surging last week. The biotech ETF jumped 11% as headline risks against drugmakers seemed to evaporate.

A draft of the President’s executive order, obtained by The New York Times, finds the impetus of the four-page document is on easing regulatory hurdles on the drug industry. Proposals in the order could scale back a federal program that require companies to discount drugs to providers that serve low-income patients. It also directs the U.S. Trade Representative to strengthen support for intellectual property rights overseas to limit generic competition on patented drugs.

Outside the White House, the Senate version of healthcare reform made no mention of drug prices or actions that would significantly affect the industry. 

Best-Of-Breed Biotech Companies With Bulging Pipelines
Sure, regulatory actions could still change and headline risk could return, but it looks like biotech may escape the worst of investor fears and now has a clear path returning to fundamentals and valuations. An aging population in nearly every developed nation supports stronger drug sales for decades, and valuations in many names have yet to rebound to long-term averages.

Within the biotech space, look for competitive advantages in research around specific disease groups. A pharmaceutical company that can develop a leadership position within a disease group can boost sales through its reputation for the treatment group and can lower R&D costs through efficiency in the area. 

These disease group leaders also become attractive takeover targets when larger companies look to strengthen their drug profile in a certain group.

Alexion Pharmaceuticals (Nasdaq: ALXN) has an unmatched focus on rare-disease drugs, which gives it pricing power and extended patent protection. The company is expanding on its breakout winner Soliris and has a strong pipeline of orphan drug candidates. 

Revenue has more than doubled since 2013 and the company is strengthening its balance sheet with over $1.3 billion in cash. Shares trade for 8.8 times trailing sales, almost half the five-year average of 16.5 times. The increase in valuation hasn’t been lost on management, with the CEO buying more than $1.1 million in shares on June 14.

Biogen (Nasdaq: BIIB) is a leader in the $20 billion global market for multiple sclerosis treatments. The recent launch of Tecfidera establishes the company’s dominance in the space for the next few years, and pipeline drugs for Alzheimer’s and other neurology diseases support a strong sales outlook.

Biogen beat first-quarter earnings and sales estimates on the success of its recently launched spinal muscular atrophy drug Spinraza. The drug is a first in its category and booked $47 million in sales during the quarter, more than 50% over expectations for $30 million. The new drug could be a blockbuster with analysts estimating between $1 billion to $2 billion in annual sales and a planned launch in Europe this year. 

Shares trade for 5.3 times trailing sales, a 21% discount to the average 6.7 multiple for the industry and well under the company’s average five-year multiple of 7.8. Biogen has also seen increased insider buying recently with board member Alexander Denner purchasing more than $20 million in shares at $278.48 per share in April.

Gilead Sciences (Nasdaq: GILD) is the market leader in oral hepatitis C (HCV) treatments and HIV drugs, both high-margin and multi-billion dollar spaces. The firm serves 80% of treated HIV patients in the United States with its three patented drugs.

Several competitors challenged the company’s dominance in HCV treatments last year and sales fell on the resulting lower pricing and smaller market share. Management has provided a wide range of $7.5 billion to $9.0 billion for HCV sales this year, well below the $27.7 billion booked for 2016.

Shares are priced for the worst, trading at just 3.2 times trailing sales against a five-year average of 6.9 times sales. However, first-quarter 2017 HCV sales held up well and the company boosted balance sheet cash to $14.1 billion. That’s more than 15% of the market cap and could signal a big deal coming to bolster its pipeline. 

Risks To Consider: Increased pricing regulation and other headline risks isn’t completely off the table, so be ready for more volatility in biotech compared to other industries.

Action To Take: After lagging for much of the year, biotech could break out to be one of the best groups of the year. Position in best-of-breed names leading in specific drug classes and with strong pipelines for growth.

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