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Will biotech stocks recover in 2015?

This article appeared in the January 2015 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.

Tough year for local prices but a positive one for capital raisings. 

Photo of Mark Pachacz By Mark Pachacz, Bioshares

It has been a horrid year for the leading medium-cap biotech stocks in Australia: Pharmaxis, once the emerging sector's flagship biotech, Acrux, QrxPharma, Universal Biosensors, Alchemia, and the list goes on.

However, in the US, biotech stocks continue to enjoy a stunning run, with more than 100 initial public offerings (IPOs) in 2014. Fortunately, this US sentiment towards biotechnology has had positive effects on the Australian sector, particularly with capital inflow, one of the largest challenges for cash-hungry biotech companies.

After more than a decade of commercialisation, this was supposed to be a period of deliverance for Australian biotechs. Yet it has been a year in which the leading mid-cap companies have stumbled.

Pharmaxis, which at its peak had a market value in excess of $900 million, is now valued at $15 million, below its cash holding of $25 million. The stock has fallen by more than 50 per cent in the past year as the company's lead product for the treatment of cystic fibrosis failed to gain substantial market traction in Europe.

Acrux's share price has fallen by 55 per cent amid concerns emerging about the use of testosterone products and the inability of the company's product to secure a more substantial market share in the US through its partner, Eli Lilly.

QrxPharma received a red light once again from the US Food and Drug Administration for its pain combination therapy. Its share price has plummeted by 98 per cent. Universal Biosensors' share price fell 61 per cent after the company finally disclosed the disappointing buy-out clause with its partner, Lifescan.

Alchemia's shares fell 85 per cent after its Phase III cancer trial showed no benefit over placebo. And Prana Biotechnology's shares fell by more than 70 per cent after a failure with its Phase II Alzheimer's disease trial.

Investors chasing growth

Over the past five years the US biotech sector has powered ahead with a sustained record bull run. The Nasdaq Biotech Index has steadily increased from 750 points in October 2009 to its current 3,240 points, a rise of 330 per cent.

Driving this interest is a combination of low interest rates, investors chasing growth rather than yield, and broad drug development success, such as that being enjoyed by Gilead Sciences, which now has a market value of $157 billion.

In the first 11 months of 2014 there were 101 biotech IPOs in the US, up from 49 in the same period in 2013, according to Burrill Media. Those companies raised US$8.7 billion and were up an average 13.5 per cent from their issue price at the end of November.

The positive sentiment in the US has resulted in improved capital market conditions in Australia from the perspective of access to capital for Australian companies. Although biotechs here have largely performed poorly, many companies have been able to raise substantial funds, which positions them well for the next 24 months.

For investors, there is the potential for strong upside if clinical and commercial milestones can be achieved, now that funding risk has been removed.

Companies that conducted important capital raisings in Australia in 2014 included Impedimed ($32.5 million), Benitec ($31.5 million), Viralytics ($27 million), Phosphagenics ($19 million), Starpharma ($19 million), IDT Australia ($18 million) and Circadian Technologies ($17 million).

Not all bad in 2014

As with any emerging sector, there comes a period of divergence, where the successful companies successfully cross the rapids of commercial danger, move into profitability and continue to grow and start to deliver returns to shareholders. On the flip side, it becomes increasingly clear which companies will not succeed and will not live up to the lofty expectations that attracted investors many years ago.

Although 2014 has seen many disappointments at the top end of the mid-cap biotech sector, there have been some very good businesses that have been created, or are being created, that have thrived.

On the top of that list is Sirtex Medical, which sells a treatment for liver cancer. It generated an annual net profit of $23.9 million. Its share price has increased by 144 per cent over the year and market capitalisation is now $1.6 billion.

Somnomed sells a treatment for snoring and sleep apnoea. The company expects to sell around 55,000 of its devices this year with sales expected to exceed $32 million. The company's share price increased by 141 per cent and market value is $135 million.

Drug developer Clinuvel Pharmaceuticals has had its drug recommended for approval by the body that advises the European Medicines Agency, which means the company should be able to launch its drug throughout Europe in time for the northern spring in April.

Clinuvel's drug, Scenesse, is a photoprotective compound used by people with severe sun intolerance. Sales in Europe alone are expected to reach up to $50 million. Clinuvel's share price has jumped 324 per cent over the year and market capitalisation is now $171 million.

Impedimed is another company in the sector that has enjoyed a stunning year. Its share price is up 212 per cent and market value is $193 million. Impedimed sells a diagnostic product used for early detection of lymphedema in patients who have recently undergone resection cancer treatment. The company recently raised $32.5 million, with substantial interest from local institutional investors. 

Other companies that have performed well commercially in 2014 include Mesoblast, which is the leading global stem cell player with a market value of $1.4 billion; Psivida, which finally saw its product approved by the FDA for the treatment of diabetic macular edema, at its third attempt; and Benitec Biopharma, which has progressed its DNA-directed RNA interference (ddRNAi) therapy into clinical studies. 

Stocks to look out for in 2015

(Editor's note: Do not read the following ideas as stock recommendations. Do further research of your own or talk to a financial adviser before acting on themes in this article).

Somnomed, Clinuvel and Impedimed should continue their good run into 2015. Somnomed expects to grow unit sales at 25 per cent and this will be assisted by a currency tailwind, with the US making up 53 per cent of sales. A move into strong revenue growth from the launch of Scenesse into wider Europe by Clinuvel should see more interest in this stock.

Impedimed, which has secured high-level reimbursement coverage from January 1 in the US, is set for a very good year and is potentially a takeover target.

Other stocks that have raised significant funds in the past 12 months and are expected to reach clinical milestones in 2015, and are worth monitoring, include: Innate Immunotherapeutics, which has a Phase II program in multiple sclerosis; Ciracadian Technologies is moving into the clinic with a combination treatment for the eye condition called wet AMD (which has recently become a multi-billion-dollar market).

Viralytics is working in the hot area of cancer immunotherapy, using a virus to treat tumours. The company has generated very good Phase II data, which was enough to attract $27 million in 2014 from specialist US biotech funds.

Immuron is conducting a Phase II 120-patient trial in early-stage liver disease (abbreviated NASH). This is also a hot area for drug developers, with no therapies currently available. Immuron expects to complete its Phase II study in 2015.

About the author

Mark Pachacz is Research Principal at Bioshares, a leading investment newsletter on biotech stocks. The author owns shares in some of the companies discussed above.

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