Biotech sector shows promise but fails to fire

Few sharemarket sectors are more frustrating than biotechnology. Australia has some fabulous life sciences companies with good management, solid balance sheets and strong commercial prospects. Yet so many of them fail to gain traction and those that do are often dumped during market weakness.

The US Nasdaq biotech index has more than doubled in the past three years, to trade near 12-year highs, underpinned by merger and acquisition activity, more interest in drugs to treat hepatitis C, and, dare I say, greater understanding of life sciences valuations by US investors.

In contrast, several Australian life sciences stocks have been hammered this year – Bionomics, Impedimed and Phosphagenics among them. More will follow if market volatility stays high. This weakness follows a 16.6 per cent fall in the PwC Life Sciences Index in the year to December 2011.

Speculative stocks are always among the first to be sold when markets tumble. Look at recent carnage in small resources stocks. Even the S&P/ASX 300 Metals and Mining Index, heavily influenced by BHP Billiton and Rio Tinto, shed 31 per cent in the year to May.

The initial public offerings (IPO) market is on track for its worst year, by capital raised, in more than a decade. Far fewer investors are buying shares in new offers, and even higher quality companies are struggling to close their offers or are having to scale back and reprice them.

Ventus Medical is one of them. The US-based company could not close its $40 million offer last month because of terrible conditions. It expected to reprice the offer but the float has been shelved. Other IPOs are also falling like flies.

But every problem is an opportunity. That does not mean they are screaming buys; you cannot argue for many speculative stocks when market volatility is high and sentiment is low. Instead, investors should focus on more advanced, high-quality life sciences companies and wait for even better value in the next few months.

The leading life sciences newsletter, Bioshares, this month did some interesting analysis on what it considers are 13 top-tier biotech stocks. Bioshares founders, David Blake and Mark Pachacz, wrote for the old Shares magazine when I edited it and I have followed their work since.

Bioshares favours more established life sciences stocks, such as Acrux and Sirtex Medical, which featured last month in the BRW cover story “Nine Hot Tech Stocks”. It says: “Stocks offering more certainty, such as Acrux and Sirtex Medical, are experiencing high demand, in preference to early-stage drug-development assets, such as Bionomics, that can expect to trade at increasingly higher discounts to their fair value in the current investment climate.

Bioshares adds: “Stocks where the future earnings should increase over the remainder of 2012, and thus market value, include Alchemia, Nanosonics, QRxPharma and Pharmaxis.” Bioshares describes Pharmaxis as an attractive investment opportunity.

It is developing therapies for under-treated respiratory diseases, and the shares have given back most their gains from earlier this year.

I would add a few others. Starpharma Holdings, also featured in BRW recently, has tumbled from a 52-week high of $1.88 to $1.29. Nothing fundamentally has changed; if anything, Starpharma has had good news with positive enrolments for its phase III trial for VivaGel, as a treatment for bacterial vaginosis. I suspect the share price fall is more about fund managers taking profits in Starpharma and reallocating them into other fallen stocks. That creates the opportunity.

Smaller life sciences stocks I follow include REVA Medical, GI Dynamics and, more recently, Osprey Medical. REVA is developing a bioresorbable coronary stent to restore arterial blood flow to the heart; GI Dynamics has an interesting product to aid weight loss and treat diabetes and obesity; and Osprey’s device treats a form of kidney injury caused by X-ray visible dye that cardiologists inject during heart procedures. Each company has listed in the past two years.

GI Dynamics and Osprey Medical are trading near their issue price, which is a good achievement given so many recent IPOs are struggling. REVA is rising again, although it remains below its issue price. These stocks have good long-term prospects and suit experienced investors comfortable with higher risk.

Those seeking more established, investment-grade life sciences stocks should stick to Acrux, Sirtex Medical, Starpharma and the much larger Mesoblast.

As dull as it sounds, the best advice is to watch and wait for better value over the next few months.

• Tweet