Biotech sector ready for break-out after four years of consolidation

I am pleased to present International Biotechnology Trust’s factsheet for October 2019

 October was an eventful month. From a corporate perspective, the Trust released its 2019 Annual Report and our Board of Directors appointed Numis Securities as the Trust’s corporate broker.

It was also a busy month for biotechnology companies. Firstly, Biogen announced it would seek regulatory approval for aducanumab, a treatment for Alzheimer’s Disease, months after the early termination of the drug’s clinical trials on futility grounds. Shortly afterwards, Vertex announced US approval of Trikafta, its latest triple combination drug for cystic fibrosis, which came five months earlier than expected. Trikafta sales are expected to exceed $6bn by 2025, while the approval means the company’s portfolio of cystic fibrosis treatments will now cover 90% of patients suffering from the disease. Vertex also generated positive headlines closer to home, when it announced it would make cystic fibrosis treatments available to patients in the UK after the company reached a reimbursement agreement with NHS England. From the perspective of the Trust’s shareholders, Biogen and Vertex are both top ten holdings and, with share price gains of 28% and 16% respectively, both were significant contributors to outperformance in the month.

Despite the positive news in October, the NASDAQ Biotechnology Index still hasn’t reached previous highs. Looking back over the last ten years, the sector performed strongly from 2010 to 2015 but, after peaking in mid-2015, the sector was thrown into the political spotlight ahead of the 2016 presidential election. High drug prices suddenly became front-page news. Four years on and the sector still hasn’t surpassed the 2015 peak.

Figure 1: 10-year performance of the NASDAQ Biotechnology Index (Bloomberg)

The chart above shows that the biotech sector has clearly consolidated. It is now trading at a significant discount to the broader market. The S&P 500 biotech sub sector has a forward 2019 P/E multiple of 11.7x, almost 50% lower than the S&P 500 as a whole.

But what are the reasons for this? Both broader market factors – slowing economic growth and trade disputes – and sector specific issues – the ongoing drug pricing debate in the US – have been leading causes in the undervaluation of the sector. Even though the market may have priced these factors in, they should be examined more closely. A slowing global economy shouldn’t have a major impact on the sales of medicines, nor should a trade war impact the supply of medicines. Regardless of both these factors, patients across the globe will demand the most effective treatments. With respect to sector specifics, tougher US regulation on drug pricing could have a significant impact on the valuation of biotech companies but, in my opinion, the market has already priced this into the sector’s low valuations. Moreover, regular readers will know that I don’t believe drug pricing regulation is set for radical change. Rather, agreement on a politically benign route forward for drug pricing could lead to a rerating of the sector and an uplift in valuation. When coupled with the ever-quickening pace of scientific innovation, it would appear our sector has rather a lot to look forward to in the long-term.

Thank you for taking the time to read our factsheet.

October Factsheet (click link to open)