Where to Place Your Bets in the Biotech Sector

Investing in biotech stocks these days is a lot like walking through a minefield. The industry has been hit hard by drug pricing scandals and increasingly tough rhetoric from some of the presidential candidates. Add to this the unfolding Valeant Pharmaceuticals International (NASDAQ: VRX) disaster, and it’s understandable why investors might want to avoid the biotech sector altogether.biotech sector bets

But for investors willing to sift through the carnage, there could be some tantalizing bargains. Biotech stocks as a whole have declined indiscriminately due to the negative headlines and escalating regulatory risk. But there are still strong companies in the biotech sector that investors can buy.

Stick With the Best-in-Breed Biotechs

It’s a scary time to be a biotech investor, and there is little certainty regarding what the future regulatory environment will look like. This is all the more reason to stick with the strongest companies if one is going to invest in the sector.

That’s why investors should steer clear of the highly risky names Valeant and instead consider two highly profitable, well-run companies: Biogen (NASDAQ: BIIB) and Gilead Sciences (NASDAQ: GILD).

Biogen and Gilead shares have declined 15% and 7%, respectively, since the start of the year. This is despite the fact that their underlying fundamentals continue to be strong.

Biogen’s revenue rose 11% to $10.8 billion last year. Earnings jumped 24% in 2015, thanks to excellent results from its drug pipeline. Revenue from its Tecfidera multiple sclerosis drug increased 24% for the year.

Gilead generated revenue of $32.6 billion last year, a 30% year-over-year increase. Its strong revenue growth was due to its flagship hepatitis C drugs, Harvoni and Sovaldi. Such strong revenue growth flowed down the income statement and resulted in 62% earnings growth for the full year. Gilead generated $20 billion of operating cash flow last year.

Valuations Are Very Attractive

In light of the heightened scrutiny over drug pricing in the United States, investors appear to believe Gilead and Biogen will suffer significant contractions in revenue and earnings this year. This could be why the stocks are so cheap.

Gilead shares trade for just 8 times trailing earnings per share and 7.5 times forward EPS. But judging by management’s forecast, these fears appear unfounded. Gilead expects only a 6% revenue decline in 2016. Similarly, analysts on average forecast Gilead’s earnings to decline 3%, which would be a rather modest drop.

Biogen isn’t quite as cheap as Gilead – the stock trades for 17 times trailing EPS and 13 times forward EPS – but that’s because the company is expected to grow its earnings by 9% this year and 7% in 2017, according to average analyst estimates. Management expects revenue to grow this year to a range of approximately $11.1 billion to $11.3 billion.

Another bonus for investing in Gilead is that the company pays a solid 2% dividend and raises its dividend regularly. When the company released quarterly earnings in February it announced a 10% dividend increase.

Final Thoughts on the Biotech Sector

Investors are concerned about biotech stocks and the potential for drug price deflation, which would threaten their margins. In Gilead’s case, the stock could be so cheap because investors are afraid that its business is overly concentrated in its top two hepatitis C drugs, Harvoni and Sovaldi. These products represent 58% of Gilead’s total revenue by themselves.

But both Gilead and Biogen have lots of cash on their books and can easily pursue merger-and-acquisition targets to buy whatever growth they may not be able to generate organically.

As of the end of 2015, Gilead held $26.2 billion of cash, cash equivalents and marketable securities on its balance sheet. For its part, Biogen has $3.4 billion in cash, $2.7 billion in marketable securities and another $1.1 billion in long-term investments.

The bottom line is that sentiment is very negative about the biotech sector right now, but Biogen and Gilead are still highly profitable, growing companies, with strong balance sheets. If their fundamentals remain strong in 2016, these stocks may not stay this cheap for long.

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Published by Wyatt Investment Research at