Choosy investors

Why 2018 will be a stock picker’s market in biotech

Despite losing steam in 4Q17, the broad-based recovery in biotech stocks last year has left investors generally comfortable with current valuations, and hence less optimistic that the sector indexes will outpace the broader market in 2018.

That doesn’t mean, however, that investors have turned bearish. Rather, the 17 buysiders who spoke with BioCentury about the coming year say prevailing headwinds should make it easier for stock pickers to outperform their benchmarks.

In fact, many investors told BioCentury the conditions for generating alpha are particularly favorable heading into 2018, and selectivity will be even more important than in prior years.

A big reason is that generalists aren’t expected to return to biotech in a big way in 2018. While their capital will be missed by some, avoiding a rotation that dangerously inflates equity values on the way in and pummels them on the way out is seen by most as a positive.

“You’re not going to see as large gains in the indexes because of the larger caps.”

Marshall Gordon, ClearBridge

Buysiders also expect M&A activity will rebound after a surprisingly slow 2017. Their reasons are both strategic and statistical.

In the former category are structural weaknesses among large cap biotechs and pharmas, which will increase the pressure on these companies to pick up new assets. The latter relates to the abnormally low level of deal flow last year, which suggests activity has nowhere to go but up.

The six bankers who spoke to BioCentury said the IPO queue is still chock full of high-quality candidates, and activity is expected to ramp up much more quickly than last year. Buysiders also said quality remains high, and indicated they are receptive to new paper.

The follow-on market is likewise expected to remain very healthy, with companies using key catalysts to secure capital at favorable prices.

Top heavy

Specialists largely agree that continued underperformance by the big caps this year will weigh down the most closely followed biotech indexes.

In the final quarter of the year, the NASDAQ Biotechnology Index (NBI) dropped 4% and the NYSE Arca Biotechnology Index (BTK) and the BioCentury 100 traded flat (see “Index Performance”).

In contrast, the Dow Jones Industrial Average (DJIA) jumped 10%, the NASDAQ Composite climbed 6% and the Standard & Poor’s 500 index increased 6%, largely driven by increasing certainty that the Tax Cuts and Jobs Act (H.R. 1) would be signed into law.

President Donald Trump signed the bill on Dec. 22, and it became effective Jan. 1.

While biotech is expected to derive fewer benefits than other sectors from the tax code rewrite, the bigger issue was its inability to recover from one high-profile clinical flop that was soon followed by weak 3Q17 earnings reports from multiple large cap bellwethers.

Celgene Corp. was the primary culprit, first announcing that mongersen failed a Phase III trial in Crohn’s disease on Oct. 19, and then following up with underwhelming 3Q17 results and a reduction in long-term guidance on Oct. 26.

Gilead Sciences Inc. and Biogen Inc. also reported weaker than expected top-line results that dented what was at best tenuously positive sentiment among the wider investment community.

ClearBridge Investments’ Marshall Gordon doesn’t necessarily expect the indexes to decline this year, but he is concerned about large cap performance and thinks it’ll constrain the space.


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