Biotech Not Cratering, Just Deflating
Adam Feuerstein
07/05/02 - 10:10 AM EDT
To see where the biotech sector is headed tomorrow, it might be helpful
for investors to look back, and more importantly, forget about, the recent
past.
The outlook from this perspective is sobering: Biotech valuations are
only now beginning to trade below historical levels, despite what seems
like a calamitous drop in stock prices. Right, you guessed it: Biotechs
could still head lower.
The Amex Biotechnology Index closed Wednesday at 309.32, quite an
accomplishment considering that a profit warning from drug-equipment maker
Qiagen and a
Genentech downgrade sank the index to as low as 290.67
earlier in the day. The drop below the 300 level was noteworthy as a
psychological, if not technical, measure of just how badly the sector is
performing this year -- down 46% for the year.
But don't call a bottom yet. The BTK has retrenched back to December
1999 levels, which is an interesting time frame because, as longtime
biotech investors will recall, the sector, at this time, was in the midst
of a bubble, inflated by the hype over genomics and, of course, the general
mania in technology-related stocks. It may seem like a distant memory, but
towards the end of 2000, the BTK actually approached 800. And as one reader
points out, enthusiasm was so great that one analyst at Credit Suisse First
Boston, in September 2000, was actually talking up the likelihood of BTK
1000.
Forget About It
We bring this up to suggest that biotech investors might want to simply
erase the roughly two-year biotech bubble from their memory, in order to
better evaluate current valuations.
That's what Lazard Freres biotech analyst Joel Sendek did recently, and
it suggested to him that biotech valuations are only now beginning to trade
below historical levels, despite the aforementioned steep slide in stock
prices since late last year.
To determine historical biotech valuations, Sendek decided to remove
the 21-month bubble period from June 1999 to March 2001 from his
calculations. He came up with a historic, average P/E for the biotech sector
of 40 times earnings. The historic average P/E-to-growth multiple is 1.6.
At the end of June, when Sendek issued his report, the average P/E for a
basket of eight profitable biotech firms was 35, while the PEG multiple was
1.47.
"Our analysis reveals that biotech valuations have only recently begun
to trade within historical long-term ranges -- for the first time since"
the first quarter of 1999, he writes. "Given what we believe to be weak
near-term fundamentals in the biotech industry, we see further downside
potential in valuations to the lower end of their historical ranges,
representing 10%-20% downside from current levels, before any major rebound
is likely."
The BTK was trading around 340 when Sendek issued his report on June
26. By his reckoning, the index will fall to the 275-310 range before any
rally occurs.
As a result of his revised valuation analysis, Sendek lowered his
Genentech rating to hold from buy. He reiterated his hold and buy ratings
on
Amgen and
Idec Pharmaceuticals(IDPH Quote), respectively, but he lowered
price targets on each. Lazard doesn't have an existing banking relationship
with any of the above-mentioned companies.
Take Genentech -- Please
Genentech offers a good example of just how fragile biotech valuations
are these days. The stock fell 5% to $28.70 Wednesday after Deutsche Bank
Securities biotech analyst Dennis Harp used the day before the July 4th
holiday to downgrade the company to market perform (read: hold) from buy.
The main reason? Valuation. By Harp's calculation, Genentech was trading at
a 2003 P/E-to-growth multiple of 1.5, a significant premium to the other
profitable biotechs, which as a group, trade at a 2003 P/E-to-growth
multiple of 0.8.
Harp also believes that Genentech will come up short when it reports
results later this summer from a Phase III trial of its experimental cancer
drug, Avastin. His firm doesn't have a banking relationship with Genentech.
Earnings season is typically a good time for biotech investors, but
Biogen and
Genzyme General have already warned, which suggests that
second-quarter results will not be bullish enough to provide any meaningful
lift for the sector. So while the BTK's ability to stay north of the 300
level Wednesday should be taken as a victory, it may only really be a
temporary reprieve.
