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The Essential Biotech Sector Fall Preview

Large-cap biotech stocks (companies with market valuations greater than $5 billion) have largely under-performed this year to date. Genzyme is up 45%, again due to the Sanofi takeover business, while Dendreon (DNDN) is up 54% and Alexion (ALXN) is up 17%.

The list of large-cap stocks in the red is longer, including Gilead Sciences (GILD) (down 23%), Vertex Pharmaceuticals (VRTX) (down 18%), Amgen (AMGN) (down 7%) and Celgene (CELG) (down 5%).

If we celebrate the winners, we must also acknowledge the losers in the biotech sector so far this year. Aryx Therapeutics (ARYX) tops the list (down 88%), followed by Marshall Edwards (MSHL) (down 88%), Adventrx Pharmaceuticals (ANX) (down 79%), Vermillion (VRML) (down 78%) and Affymax (AFFY) (down 75%).

The performance of the mid-cap biotech stocks is more mixed, with 20 stocks up for the year compared to 21 stocks in negative territory, according to data compiled by ISI Group.

The large- and mid-cap biotech stocks that have under-performed this year have done so largely because uncertainties over healthcare reform, drug price cuts in Europe and reimbursement pressures in the U.S. have hurt revenue and earnings growth, said ISI Group biotech analyst Mark Schoenebaum.

And to the extent that these trends continue in the midst of a U.S. economy still struggling to recover, biotech valuations measured by price-to-earnings multiples may continue to compress as they have for most of this year, added Schoenebaum.

The argument for better performance from the biotech sector through the end of the year starts with a pickup in mergers & acquisition activity. A Sanofi purchase of Genzyme, especially for a price in the high $70s, would help reinvigorate the old saw that Big Pharma needs to buy biotech companies in order to restock their depleted drug pipelines.

Big Pharma is sitting on piles of cash, which only adds more fuel to the speculative fervor around continued biotech M&A.

The biotech sector's performance will also pick up steam through the end of the year if the negative impacts from European drug price cuts and the U.S. healthcare reform are found to be less hurtful than expected, said Schoenebaum.

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