Biotech Bubble? Or Buying Opportunity?

Two weeks ago Gilead Sciences (NASDAQ:GILD) received a letter from three members of Congress. In that letter, lawmakers asked for a briefing from Gilead regarding the pricing of its new hepatitis C drug Sovaldi, which Gilead is selling for $1,000 per pill.
The gist of the letter is that Congress is asking the company to justify the cost of treatment, which comes in at around $84,000 per patient. And they’d like the briefing to be done before April 3, which is tomorrow.
That letter sent the entire biotech sector into a tailspin as investors became concerned that biotech companies would have to yield to pricing pressures. The fact that biotech has been the best-performing sector in the S&P 500 for three straight years, and was leading again in 2014, led many investors to sell first, and (maybe) ask questions about the biotech bubble later.


I recently sat down with Wyatt Research’s Chris Preston, who wanted to hold my feet to the fire and see if I was still bullish on biotech. He let the questions fly, and this is what I had to say:
Chris: “Let’s get right to it here. Was biotech due for a pullback?”
Tyler: “Yes, I think so. The sector had been up 20% YTD in late February, and was still up 16% YTD when GILD got that letter. After rising by 22%, 38% and 74% in 2011, 2012 and 2013, respectively, it’s not surprising that investors were a little trigger-happy when it came to biotech stocks.”
Chris: “Does this letter mean that we should question GILD’s growth potential, and apply those same concerns to other biotech companies?”  
Tyler: “No, I don’t believe so. GILD’s Sovaldi treatment is incredibly effective, curing around 90% of patients after 12 weeks. That cure rate is 10% better than the standard-of-care treatment, it works in half the time and with far fewer negative side effects. Moreover, the standard-of-care treatment costs around $100,000 per year, and according to a Mt. Sinai study, as much as $189,000 “per cure.”
So in effect, GILD’s treatment is more effective, quicker, less harmful and cheaper than the standard-of-care treatment. Based on the data, it seems Congress is making an example of GILD for other reasons.
I don’t think we should discount the entire sector’s potential based on one letter questioning pricing for one new drug. And furthermore, the timeline for drug development is extremely long, measured in years, not months. I doubt that a conversation about pricing for one drug now is going to crush revenues for all new blockbuster drugs to hit the market between 2013 and 2017.”
Chris: “Why do you think Congress is making an example of GILD?”
Tyler: Obviously health care is incredibly expensive. Democrats are trying to show support for reform, and one way to get attention is to highlight a high-profile treatment, like GILD’s Sovaldi, which is basically a cure for hepatitis C. Congress is concerned that a treatment will not cure patients if they cannot afford it – which is a valid concern. Also, the drug received expedited approval from the FDA, and these members of Congress seem to think that GILD didn’t factor that into its pricing.
Congress wants answers to some legitimate questions. But frankly, I don’t think GILD is going to come up with the answer to the problem of rising health care costs by tomorrow.
Chris: “What is valuation like in the biotech space right now? Are these stocks cheap, expensive, or somewhere in between?”
Tyler: “On a valuation basis, biotech looks good to me. If we look at consensus estimates for 2016, the four largest biotech companies trade at just 13.5-times earnings, versus 14.2-times for the S&P 500.
These companies are growing far faster than the S&P 500 … over the next three years revenues should grow at 18% a year, versus 4% for the S&P, and earnings by 30% per year, versus 6% for the S&P.
So let me ask you a question: Would you buy into a sector where net margin is 2.6-times that of the S&P 500, which is growing EPS five-times faster and growing revenue 4.5-times faster, and that’s trading at a 5% discount based on 2016 estimates?”
Chris: “Well, you make a compelling case. And given that you just doubled your subscribers’ money with small-cap biotech stock Endocyte (NASDAQ:ECYT), and have them up 30% with Gilead in a few months, I think our readers would be wise to follow your advice and take a closer look at big biotech. Thanks, Tyler.”

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