Morgan Stanley Cuts Rating on Biotech Sector

The firm says valuations are getting high among biotechnology stocks.
By TSC Staff ,

Updated from 9:42 a.m. EDT

Biotechnology stocks have enjoyed a nice run over the past few months, and now Morgan Stanley says that means investors should take some profits from the sector.

The firm issued a research report Wednesday morning, downgrading the biotech sector to in-line from attractive. Morgan Stanley said the majority of the companies it follows are at or near its 12-month price targets, and that it's "time to take some money off the table."

An in-line rating means that Morgan expects the industry to perform on par with its relevant broad market benchmark over the next 12 to 18 months.

Morgan pointed out that since the start of 2003, the Nasdaq Biotech Index is up 21.4% and the Amex Biotech Index has climbed 19.9%. By comparision, the

Nasdaq

has gained 11.6% and the

S&P 500

has risen 4.5% over the same period.

"While there are still a number of near-term positive catalysts for the sector, with the likely approval of four additional drugs in the next two months, strong

second-quarter earnings ... and continued supernormal growth, we believe that valuations are beginning to reflect this reality," the firm's research note said. "Growth rates are beginning to slow for the large-cap sector going into the latter half of 2003 (tougher comps and maturing products) and beyond."

Even though fundamentals have "significantly improved" over the past year, with current valuations "we struggle to find stocks that we believe can meaningfully outperform the broader market in the near term."

Additionally, Morgan said that the summer months are usually weak for the biotech sector as news flow tends to slow.

Morgan noted that the biotech sector has seen five drugs approved this year, and that as many as 16 new products might be given the green light by the time 2003 comes to an end.

"This strong number of new products (which drive the next profit cycle) keeps us from moving to a cautious industry view and could lead to an upgrade of the sector if valuations come in, but we believe that much of this good news is priced into the stocks at current levels," the firm said.

The biotech rally has rewarded many names in the sector, including lower-growth and higher-risk names, Morgan said. The firm indicated that it was suggesting investors stick with "high quality, later-stage biotech names with solid top- and/or bottom-line growth."

Specifically, Morgan said it continues to believe investors will be better off with

Amgen

(AMGN) - Get Report

and

Gilead

(GILD) - Get Report

among large-cap stocks. Morgan was also positive on

Medicines Co.

(MDCO) - Get Report

, despite "some near-term risk on manufacturing." The firm said it believes "the underlying fundamentals of the business remain strong" at Medicines Co.

For investors willing to assume more risk, Morgan said it favors

Atherogenics

(AGIX)

,

Human Genome Sciences

(HGSI)

and

OSI Pharmaceuticals

(OSIP)

.

In short, Morgan said "we view ligtening up on the sector as prudent, given current valuations." The firm said investors should use any momentum from near-term positive news that comes out of the American Society of Clinical Oncology meeting or additional Food and Drug Administration approvals as an opportunity to rotate some money out of the sector.

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