3 ways to spot biotech stars in 2017

Photo of Mark Pachacz, Bioshares By Mark Pachacz, Bioshares

min read

Leading drug developers achieve market revaluations – but understand the risks.

Over the past two years, investors have been gun-shy and steered clear of the riskier end of the biotech spectrum, those companies that are developing innovative drugs.

It is a high-risk and long process to bring a new drug to market from scratch, and very expensive. A series of drug development failures in the sector three to four years ago, has seen these biotechs largely ignored by investors and thus, trade at substantial discounts to fair value.

That inefficient market pricing was some way rectified in 2016, with many drug development stocks delivering stellar gains for the committed biotech investors.

(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.)

Biotech stars in 2016

Top of that list was multiple sclerosis (MS) drug developer Innate Immunotherapeutics, whose share price soared 476 per cent for the year. Innate is developing a drug for the treatment of a form of MS, called secondary progressive MS. There are no current therapies, with 70 per cent of people with relapsing-remitting MS progressing to this untreatable state within 20 years of illness.

The technical risk for such a difficult-to-treat disease has been significantly lowered with Innate because it has been treating patients in New Zealand for eight years under a Compassionate Use program. It has been found that 70 per cent of patients have reported significant improvements in their disabilities when treated with the Innate drug candidate, as well as an improvement in their quality of life. This is an impressive outcome given that an approvable drug for this disease would likely only need to show a slowing in disease progression.

Innate is now conducting a Phase IIb trial that will compare its drug candidate’s performance against placebo, which is the key measure for pharmaceutical companies. If results, due for release in August/September this year, are positive, the company plans to transact a sale (most likely) of the business.

Innate’s largest shareholder is New York congressman Christopher Collins, who owns 21 per cent of the business, including through family interests. Collins is a very close supporter of US President Donald Trump.

What gave the share price a move along in late 2016 was news that another US Republican, Tom Price, is also a shareholder in Innate. Price was nominated by Trump to become Secretary of Human and Health Services, which oversees medical bodies in the US, including the FDA, CDC, NIH and CMS.

(Price indicated he would divest his positions in healthcare stocks before he assumed the role.)

Other investors include former congressman Bill Paxon, Collins’ chief-of-staff, and even the head coach of the Dallas Stars hockey team.

Clinuvel Pharmaceuticals, which commercially launched its drug in Europe during the year, gained 183 per cent. Its drug, Scenesse, is now on the market for treating an orphan disease associated with people who have a severe intolerance to sunlight.

Opthea is in Phase II trials to improve existing treatments for wet AMD, a degenerating ageing condition of the eye. Its share price grew by 111 per cent in 2016.

Viralytics is developing an oncolytic virus technology that has achieved very encouraging results in mid-stage trials in treating advanced melanoma. Its share price increased by 80 per cent over the year.

Foreign investors attracted to ASX-listed biotechs

What is interesting is that while Australian investors have largely ignored these stocks, each of the companies raised significant funds from US or European investors in the past three years and those investors are now sitting on very handsome gains.

  • Innate raised $2.4 million from sophisticated US investors in June last year at 25 cents a share (Innate’s share price at time of writing is $1.77).
  • Clinuvel raised $8.3 million in March last year at $3.30 a share from US and European funds (current price $7.96).
  • Opthea raised $17.4 million in October 2014 at 17.5 cents from US, European and Australian funds (current price 88 cents).
  • Viralytics raised $27.1 million in March 2014 at 28 cents a share from US biotech venture capital funds (current price $1.125).

It was not just drug developers that performed well in 2016. Nanosonics has invented a new disinfection system for intracavitary ultrasound probes. Its system, called Trophon EPR, is quickly becoming the gold standard in the US, selling around 4,000 units a year into the US, into a market estimated at 40,000 systems in total. Its share price increased by 68 per cent and the company now has a market value of $908 million.

Cogstate, which provides cognition testing into pharmaceutical trials, including in Alzheimer’s disease, is now generating around $40 million a year in sales, up from $12 million four years earlier.

The biotech sector has been renowned each year for several companies that have disappointed on drug development. However, in 2016 the only headline stumble in the sector was Sirtex Medical, whose share price tumbled 65 per cent for the year. This was after a sales growth downgrade that was poorly received by the market because the stock was priced for perfection.

Three strategies for 2017

For investors looking towards the biotech space in 2017, three potential investment avenues could be considered. One is the leading drug development stocks that are reducing risk through progression in clinical studies, with several of those listed above.

However, investment returns are likely to be more measured than the gains experienced over the past two years because of more-efficient market pricing. Clinical study results from Opthea, Innate, Starpharma Holdings, Factor Therapeutics and Viralytics will be the share price drivers for these stocks in 2017.

Another option is looking at the more-established medical device or equipment manufacturers or service companies. There is an increasing pool of companies achieving in excess of $30 million of annual sales and have become profitable, high-growth businesses. Included in this list are Nanosonics, Sirtex Medical, Somnomed, Cogstate and Acrux.

Clinuvel Pharmaceuticals is expected to be added to this list in the year ahead. Other high-growth medical device stocks to keep an eye on include Dorsavi, Impedimed and AirXpanders.

A third option is a new wave of biotech listings that is expected to continue in 2017. Last year there were 14 new and backdoor listings and the sector now has 124 ASX-listed companies.

Companies in the e-health space should continue to attract investor interest. ResApp Health, which is developing a diagnostic that can be used over the phone to differentiate respiratory conditions, achieved a 248 per cent gain in its share price last year.

One disease area that has been the centre of many major commercial deals in the past two years is fibrosis and inflammation. This trend is likely to continue. Pharmaxis signed a deal in 2015 worth up to $750 million (including a $39-million up-front payment) with German pharmaceutical group Boehringer Ingelheim. An additional milestone payment is expected this year of $25 million and a second licensing deal may also be on the cards.

Other groups working in inflammatory diseases and fibrosis include stem cell group Mesoblast, Adalta (a new listing in 2016) and Immuron.

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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