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Biotech bull sector running hard

This article appeared in the February 2014 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.

Seven stocks to watch in the latest, possibly longest, life-science sector boom.

Photo of Mark Pachacz By Mark Pachacz, Biotech Select Fund

Biotech stocks are flavour of the month at the moment, both in Australia and the US. In the US, the Nasdaq Biotech Index, which is a good measure of the global industry's performance, is trading at all-time highs, having increased by a whopping 66 per cent in 2013.

In Australia, biotech stocks rose on average by 53.6 per cent in 2013, according to the investment fund Bioscience Managers. What is driving the interest both locally and abroad and how long will this biotech bull run last?

A brief history of biotech booms

In the early 1980s the genetic revolution came through in the form of genetic engineering, delivering the world highly effective biologic drugs, or protein and antibody drugs, rather than the small molecule (chemical) drugs that had been the basis of most pharmaceutical products up to that point.

Before 1982 the only type of insulin available was that sourced from pigs, but in October 1982 the US Federal Drugs Administration (FDA) approved the first biologically produced insulin, made by Eli Lilly using bacterial organisms in a reactor. That approval arguably kicked off the global biotechnology industry that we have today, with biologic powerhouses formed in the 1980s, such as Genentech (now part of Swiss company Roche), Amgen (market capitalisation US$90 billion) and Genzyme (now part of French company Sanofi).

Since 1982 the US biotech industry has experienced very regular four-to-five-year cycles. Following a period of booming interest from investors, billions of dollars has been raised to pay for the development of the next wave of products, licensed or sold five years later.

The second biotech boom in the US was in 1986, when Genentech received approval for its biologic drug, synthetically created human growth hormone. In the same year biotech company Hybritech was sold for US$375 million, which showed investors for the first time that a lot of money can be made from biotech.

The 1991 biotech boom was also driven by new product development. Another boom year was experienced five years later in 1996 when the power of genetic engineering started to be applied to agricultural products, including genetically modified foods and materials.

In 1999 the US biotech industry experienced the biggest boom year yet, as measured by IPOs - 63 companies were listed, with 26 in Australia a year later. The driver behind this surge of interest in the sector was the sequencing of the human genome. It was thought at the time that this breakthrough would rapidly escalate the understanding of disease in the human body and accelerate drug development throughout the world.

In reality, the wealth of knowledge gained from sequencing the human genome has added layers of complexity to drug development. However, benefits are being realised through genetic diagnostics to prevent disease, and in personalised medicines, screening which patients can be expected to respond from a particular drug based on their DNA makeup.

In 2003 there was a short-lived biotech boom following a Phase III trial result from Genentech's cancer drug Avastin, which has since been approved and is a very effective therapy in stopping tumour growth.

The next biotech boom was due to occur in 2007/2008, but the sector skipped a cycle because of the GFC. The outcome is that the 2013 biotech boom is twice as large and may last twice as long, with 49 biotech Initial Public Offerings (IPOs) in the US in 2013. This is good news for biotech investors in the US and Australia.

Underlying triggers driving US surge

There are other factors behind the booming US biotech sector outside this cycle phenomenon. The trigger for the current boom was undoubtedly the acquisition of antiviral company Pharmasset at the end of 2011 by Gilead Sciences.

Pharmasset was bought for US$11 billion, remarkably with its lead drug candidate (for the treatment of hepatitis C) only at the Phase II stage of development and no products on the market. This drug has since been approved and allows hepatitis C infection to be treated for the first time with tablets only (no injections) and without the unpleasant drug interferon. This drug is expected to generate billions of dollars in annual revenue.

Another driver in the US biotech sector is the change by the regulator to help bring drugs to market through the "Breakthrough Therapy" designation. This potentially allows drugs for unmet clinical need to be approved after only Phase II trials, rather than Phase III trials. Also, record low interest rates in the US are also pushing money towards growth stocks such as biotechs.

Impact on Australian biotech sector

Interest in the biotech sector in Australia started to heat up about six months after the US biotech market took off, around May/June last year. The direction of that interest in 2013 is worth analysing when trying to pick stocks in the sector for 2014.

As mentioned, on average biotech stocks in Australia increased by 53.6 per cent. But the weighted index (which accounts for market capitalisation), as measured by the Bioshares Small-Mid Cap Index, increased by only 14.5 per cent over the year. What this tells us, and was indeed the case, is that the interest last year was in the smaller and more speculative stocks, with some larger companies disappointing investors and missing key milestones.

The best performers for 2014 were Admedus (up 638 per cent), which has recently launched its wound treatment product for the repair of heart defects; Oncosil Medical (up 420 per cent) which will move its cancer therapy into Phase III trials shortly; and Isonea, which has an App for the measurement of asthma.

It was a year in which early-to-mid-stage drug development companies, which represent the more speculative end of the market, performed very well. These included Prana Biotechnology (up 267 per cent), Neuren Pharmaceuticals (up 229 per cent) and Bionomics (up 110 per cent).

Outlook for 2014

For 2014, the stocks to monitor will be those with products reaching the market or approaching major clinical milestones, as well as some of the more established biotechs with revenue streams that were overlooked in 2013 and will also benefit from a weakening Australian dollar.

(Editor's note: Do not read the commentary below as stock recommendations. Do further research of your own or talk to a licensed financial adviser before acting on themes in this article. Smaller biotechnology stocks generally have higher investment risk).

Stocks to look out for in 2014 are:

  • Tissue Therapies, which expects to receive European approval to sell its wound healing product VitroGro.
  • Universal Biosensors, which expects to launch its second diagnostic product through Siemens by mid-year.
  • QRxPharma, which is awaiting US regulatory approval for its combination pain therapy product.
  • Alchemia, which has a major Phase III trial outcome for its cancer therapy around mid-year.
  • Ellex Medical Lasers, which is due to receive approval in Europe to sell its lasers for the treatment of early AMD.
  • Oncosil Medical, which plans to start its Phase III trial in the first half of 2014.
  • For one of the better-performing, revenue-generating stocks in the sector, sleep treatment company Somnomed is one that should be on investors' watchlists.

The biotech bull run in Australia has been under way for nine months. Given the multiple factors that are driving the interest in the US, and that the last bull market was missed in 2007 because of the GFC, there is a good chance this current cycle may run longer and harder than normal, for at least another 12 months.

However, for that to occur here, Australia's leading stocks need to start hitting some major milestones, one factor that was missing in 2013.

About the author

Mark Pachacz is a Research Principal at Bioshares and Chief Investment Officer of the Biotech Select Fund. He has a financial interest in some of the stocks discussed in this article. Email Mark for more information.

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