In 2014, we still see outperformance for large-cap biotech
Biotech stock and financing strength YTD 2013 makes some skeptical that the trend can continue in 2014. In addition, biotech has been volatile near-term because of federal government instability & some recent setbacks in the small/mid cap biotech. In this 20 pg report, we explain why we believe large-cap stocks are still well-positioned to outperform in 2014. Our conviction is based on analysis of 1) historical trends in biotech and 2) fundamental trends. As a result, we would be adding to our top-conviction large-cap picks Gilead, Regeneron, Biogen, Celgene, and Amgen.
2013 was an outperformance year for all of biotech, can it continue in 2014?
Small, mid, & large cap biotech is up by 66%, 57%, & 62%, respectively (vs. the S&P up 19%). Financing in’13 is up 51% yoy. Success has been driven by new product success in the large-cap space (Biogen’s Tecfidera launch, Gilead’s HCV and cancer success, Celgene’s pancreatic cancer success, and Amgen’s acquisition of Onyx (which was well-received by the street).
Historically in the year post biotech outperformance, large-cap greatly outshines small/mid-cap, pharma & the S&P.
There were two periods (‘00 & ‘07) when biotech was strong and could resemble trends similar to 2013. We analyzed these two periods and biotech performance one year after these biotech bull markets. We believe 2008 is the better year as a comparison due to similarity in the PE multiples (21.6x vs. 21.7x current) and premium to S&P (50% vs. 55% current). Despite the weakening macro in ‘08, large cap biotechs had positive avg. returns of +9% vs. small/mid cap biotech returns of around -30% vs. -26% avg returns for big pharma and -38% avg. returns for the S&P-38%. Top-line growth in ‘08 was 25% vs. 16% in ’14 (consensus). Bottom-line growth in ’08 was 27% vs. 29% in ’14 (consensus)
We see a similar trend in 2014, supported by blockbuster new product launches, earnings acceleration, diversification, & pipeline upside opportunities
We believe this large cap biotech outperformance would continue as the 3 year EPS CAGR for biotech is 23% vs. 9% S&P500 using consensus estimates and 33% using DB estimates. This translates into a 150-270% premium to the S&P while the biotech PE premium is still low at 55%. S&P top-line is expected to grow at 4% in same period vs. consensus & DB est for biotech at 15% & 19%, respectively. 3 of 4 large caps have big launches in 2014 including Celgene’s Apremilast (DBe peak $3.5B), Gilead’s sofosbuvir (DBe peak $12B), Biogen’s hemophilia franchise (DBe peak $3B). We see 40-65% upside to current stock price on a blue sky scenario from our target price.
We see five reasons fundamentally to remain long the large-cap biotech space
We still favor large-cap for the following reasons 1) more diversified businesses, 2) pipeline innovation 3) new product launches 4) strong balance sheets 5) strong free cash flow profiles.
We are selectively positive on small & mid-cap names as they do carry more binary event risk and less strength on top & bottom-line
We like Vertex (46% upside from $104 TP), Pharmacyclics (38% upside from $170), Tesaro (123% upside from $80TP), and Alnylam (36% upside from $80 TP), and Sarepta (50% upside from $71)