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The biotech sector had suffered a steep decline by the end of 2021. While it is far from recovered, this generalized “Biotech Rout’ have also put the stock of individual attractive company under their real value.
So, what are the most undervalued biotech companies in early 2023?
If there is one investment sector that does not yield well to purely mathematical analysis, it is biotech. This is because the value of a company can be highly reliant on future innovations. And such potential will not be apparent at first on a balance sheet or a cash flow statement.
This is very different from, let's say, finding undervalued utilities or industrial companies. These companies have relatively predictable income and costs. So, looking solely at the P/E ratio or free cash flow is a good way to find which might be undervalued.
This is not the same for biotech stocks. Most of the time, biotech stocks will have fully priced in the incoming new drugs way before it shows in the revenues. So, the task of finding undervalued biotech stocks cannot rely on quantitative factors.
Instead, we used a more subjective (but more relevant) mix of:
- A good quality pipeline of innovative drugs.
- A good track record of R&D achievement or the backup of larger partners.
- A stock price that has declined due to the sector rout but not triggered by bad news on clinical trials or commercialization potential.
- If possible, good financial metrics like earnings and cash flows.
- Or at least a good cash balance, reducing the risk of dilution.
This is a company we have covered in detail in 2 recent articles comparing it to its competitors:
CRISPR Therapeutics uses the CRIPSR-Cas9 technology to edit genes in patients suffering from serious and deadly diseases. It is especially active in blood diseases, cancer therapy, and diabetes.
What makes CRISPR attractive is how advanced its research program is for its blood therapy product. The marketing Authorization Application (MAA) has already been submitted in the UK and EU.
Current pricing also discounts heavily its other programs at early stages, even if its partnership with ViaCyte could permanently solve Type-1 Diabetes for millions of patients.
With the explosion of gene therapies and tools for medical researchers in genetics, the demand for machinery in this field is growing extremely rapidly. One day, a full genome sequence will likely be a normal part of everyone's medical treatment.
This is also a niche market dominated by just a handful of companies holding a quasi-monopole on this technology.
By far, the leader of the sector of Next-Generation Genomics (NGS), if measured by the number of machines installed and revenues, is Illumina.
This is also a company that we covered previously in this article, comparing it to its smaller competitor, pacific Bioscience.
It is currently challenged by startups in its home domain of genome sequencing but is likely to stay the dominant player with its new generation of sequencer, NovaSeqX, already sold out. It also owns Grail, a liquid biopsy company that detects cancer early from a blood sample.
Regeneron's main product is Duxipent, an autoimmune disease drug. It sells Libtayo, a cancer drug that recently got approved for a new medical indication. Both drugs are sold through a partnership with Sanofi.
In February 2023, it also saw its Eylea drug approved for 5 conditions, treating Retinopathy of prematurity, the leading cause of blindness in children. The company collects all US revenues and splits the revenues with Bayer for non-US markets.
It also has a very large pipeline of products in 9 different therapeutic areas. 10 products are in phase III clinical trials, 9 in phase II, and 21 in phase I.
The Q4 2022 quarter saw a growth in revenues of 14% year-to-year.
Vertex is the leader in Cystic Fibrosis treatment, a deadly genetic disease, with 4 different treatments targeting different patient profiles. Patients who cannot be treated with the current therapy have a drug in phase III of clinical trial, Vanzacaftor. They are also developing gene therapy for cystic fibrosis using mRNA technology.
They partner with CRISPR Therapeutics to help develop the blood disease gene therapy mentioned above.
They also have their own product in development for Type-1 Diabetes.
Lastly, their VX-548 treatment for acute pain is the last stage of development and might be a new alternative to opioids, without the risk of addiction and fewer side effects.
One of the largest pharmaceutical companies in the world, with a total revenue of €44B in 2021. Bayer has been the world's leader in agricultural products (seeds, pesticides, herbicides, insecticides, drones, digital mapping, satellite imagery, carbon markets) since its acquisition of Monsanto.
The pharmaceutical activity, under prescription and over-the-counter (OTC), is roughly half of the company's revenues, with the other half made of the agricultural business. It covers a large spectrum of therapeutic areas, with a third of its sales in the cardiovascular segment.
The company stock has suffered from a lot of negative attention due to lawsuits regarding the cancer risk of Monsanto’s legacy herbicide RoundUp. The company has put aside $16B to cover the expected future costs of these trials, leading to temporary large losses and a steep decline in its stock price, putting its total market value below what it paid to acquire Monsanto.
The company is innovating in agriculture with RNAi plant varieties able to fight off pests with gene modification instead of more polluting pesticides. It is also a leading venture fund provider to agricultural and healthcare startups through its Leaps by Bayer department.
In healthcare, Bayer's focus on innovation is on
- Eye treatments, in partnership with Regeneron (Eylea is the second best-selling drug of Bayer)
- Stem cell treatments for Parkinson's disease and heart attacks, in partnership with BlueRock Therapeutics.
- Gene therapies, in partnership with AskBio.
- Oncology (cancer treatments): 2 drugs in clinical trials in phase III, 2 in phase II, and 8 in phase I.
Building an Undervalued Biotech Portfolio
When a company is undervalued, it can be for various reasons.
Knowing why and if the risk fits a specific portfolio is important.
It can be the uncertainty about the future, like for companies with just a drug in development and no current cash flow like CRISPR Therapeutics. If something goes wrong in the R&D process and FDA approval, it could wipe out most, if not all, of the company's value.
It can also be due to a specific setback, like Bayer’s RoundUp lawsuits. Then, what matters is to evaluate the total legal risk and if the company valuation is low enough to consider that this risk is already priced in or even over-estimated.
And it can be that the market underestimates the long-term potential of the company, like Vertex venturing beyond cystic fibrosis treatments. Or discount its dominant position in a growing market, like Illumina.
In any case, investors in undervalued biotech stock will need to do a few things:
- Patient and long-term-focused, as most undervaluation can last months or years.
- Alert and mentally flexible, as some of the risks might indeed materialize and change the investment case.
- Diversified, as often biotech stocks have a “black or white” outcome, either a large success and financial returns or a failure and brutal stock price decline.
- This is due to the binary nature of biotech R&D efforts, with innovative drugs being approved or not after years of spending and research. This means that investors in this sector have to carefully diversify and not go “all-in” on any single stock.