Rudi Van den Eynde, head of thematic global equity, Dexia Asset Management, writes about opportunities and risks in the biotechnology sector.

Rudi Van den Eynde, head of thematic global equity, Dexia Asset Management, writes about opportunities and risks in the biotechnology sector. The views are those of the author and not necessarily endorsed by this publication.

The biotechnology sector has delivered a highly impressive market performance over recent years and investors many rightly wonder just how long this can go on for. So, what is the future outlook and what opportunities look exciting as we move into 2014?

The case for biotech investing looks strong, because the products of these firms have become extremely important in the medical world. This is particularly the case in the US, which remains the prime driver of the industry.

Biotechnology has undergone a boom period over the past 10-15 years. Throughout this period we have seen ongoing improvement in the field of scientific instruments and a great deal of new insight into the existence and underlying origins of many diseases.

This has served to provide numerous opportunities for the development of new medicines that have quickly become extremely important to different parts of the market.

One of the key reasons for this is that biotechnology-based medicines are often specially designed to act both on specific intracellular and extracellular receptors and signals. As a result, such medicines offer a greater chance of success, while typically generating fewer side effects than “classic” pills.

Since the first antibodies to emerge from this approach - such as the cancer drugs Rituxan and Herceptin - came to the market at the end of the 1990s, we have seen a wide range of successful products launch. Today, six of the ten most used drugs in the world are biotechnology products including the biggest selling drug worldwide: Humira.

Such scientific progress does, however, come at a price. It tends to be expensive to target small patient groups and undertake extensive R&D and as a result, corresponding prices have to be charged.

Benefits

However, biotechnology firms often benefit from the fact that their marketing costs tend to be limited. This is because biotechnology drugs are generally used in the treatment of life-threatening diseases and disorders for which the patient has to visit a hospital.

In this sense, pharmaceutical innovation often means high profitability and better treatment goes hand-in-hand with good investor results.

Despite this, there will eventually have to be a “bio-generic industry” that enables cheaper first-generation biotechnology drugs. This in itself does not have to be a negative for the sector, as it will benefit the big biotechnology firms that will also manufacture these “biosimilars”.

A good example of how this could work is seen in the treatment of lung cancer. Certain lung cancers show the high incidence of a specific receptor, known as the epidermal growth factor receptor. This is how cancer cells get strong growth impulses and, by blocking this with an inhibitor, the patient’s lot can be improved.

Tarceva, developed by OSI Pharma and Genentech (now part of Roche), is one such drug. OSI Pharma was, in turn, taken over by Japanese group Astellas in 2010. As the cancer cells are developing a certain resistance to the drug, the race is on for a successor that offers the same result, but with less resistance. The US’s Clovis Oncology looks a good bet in this instance.

As we move into 2014 there are some exciting companies in the biotechnology sector that investors should be aware of.

One such opportunity is Biogen, which is one of the most innovative biotechnology firms in the world. This US-based firm invests much of its turnover in the treatment of multiple sclerosis, with drugs such as Avonex, Tysabri and the recently launched Tecfidera, which has been extremely successful in the US.

Biogen is highly profitable and has a price to earnings ratio of 21. This is based on expected earnings for 2014 that are certainly not too much for a company that has increased its turnover by an average 11 per cent over the past five years and that now has a promising pipeline of new drugs. 

Switzerland’s Roche is another highly successful firm that has developed three of the six best-selling biotechnology medicines. Roche is a market leader in innovation and any overview of their new-products pipeline would run to several sheets of A4 paper. The outcome is a price to earnings ratio of 15.9, based on estimated earnings for 2014 from a firm that annually generates substantial free cash flow.

Then there’s the smaller German firm Biotest, which specialises in filtering immunoglobulins and albumin from blood donations, just like larger competitors such as Baxter. This activity alone, which accounts for annual turnover of €500 million, is by itself almost worth the equivalent of Biotest’s market value.

In addition, the firm is currently developing two therapeutic antibodies that are both in the phase II clinical testing stage. One of these (BT-062) has been seen to cure 100 per cent of breast cancers in animals. Although this doesn’t mean that it will be equally successful with humans, the fact that this drug isn’t included in the company’s valuation should limit price adjustments if the drug fails to work for humans.

Of course, there are many risks linked to the development of medicines. As a result, investment in individual biotechnology firms is only for the most risk-tolerant and best-informed investor and is best placed as part of a diversified biotechnology investment strategy.