Biotech Back From The Dead

By James Brumley | June 27, 2008 AAA

If I wasn't seeing it with my own eyes, I might not believe it. Biotech may well be on the road to recovery. Over the last calendar month, the Biotech HOLDRS (AMEX:BBH) have gained 4.6%, while the S&P 500 has fallen 4.3%. Take into account the June 26 drop and BBH is still up about 3% and the S&P 500 is down about 6%.

That, in itself, isn't a reason to dive in blindly, but it sure got my attention. The next step in my due diligence process was determining whether the price appreciation is justified, and more importantly, whether more is justified.

As usual, I found some stocks in the group looked healthier than others. In general, though, the smaller it was, the more likely the company was to be attractive. Just bear in mind that future earnings potential can be more important than current revenue in the biotech arena. (For more on future earnings, check out Revenue Projections Show Profit Potential.)

The Good
Emergent BioSolutions
(NYSE:EBS) got a honey of a deal last month with its purchase of Protein Sciences Corporation's FluBlok and its platform. FluBlok is in Phase III testing, and has been given "fast-track" status from the Food and Drug Administration (FDA). The exact price tag of the deal is a little nebulous, but is starting in the $70-$80 million range for the life of the payment plan.

The attraction to EBS is the price - a price-to-earning (P/E) ratio of 9.7 and a forward-looking multiple of 11 are much better than average. Just remember, the acquisition of FluBlok has not yet shown up on the company's 10Qs. When it does, that could take a bite out of the numbers. Of course, with the FluBlok vaccine in Phase III - and fast-tracked - the expense of the purchase could be offset by growth in the top line.

If you're also a value-seeker, you may want to take a look at Enzon Pharmaceuticals (Nasdaq:ENZN).

To make a long story short, Carl Icahn is a major Enzon shareholder. When attending the most recent shareholder's meeting, he said (even if the timing was inappropriate) Enzon would be better valued if broken into its parts. The divestiture wheels began spinning soon after.

The stock has been on the mend ever since that meeting, gaining 46% since May 22. But, considering that the P/E is still only 5.74, and the price-to-sales ratio is an incredible 1.79, Icahn may well have been right. There could be a lot more upside as more of the company's value is unlocked. (For related reading, see Use Breakup Value To Find Undervalued Companies.)

The Bad
A few months ago I mentioned Celgene (Nasdaq:CELG) in a slightly negative light (to read my original take see, Biotech's Best And Worst ). My worry was simply that with a trailing P/E of 117 (ttm) - or even a forward-looking multiple of 42 - was still too frothy; meeting its earnings objectives would only "price" the stock appropriately at its then-current level, leaving no real room for further upside.

As it turns out, my worry was more than justified. Celgene didn't come close to reaching the market's expectation, though a one-time charge was the culprit for the earnings woes. At this point though, with most of the earnings drag behind them, I could understand warming up to a company like Celgene.

My worry is the same, however, Celgene seems to have a lot of expectations for Revlimid and lung cancer drug Amrubicin, which is still in trials and will be for a while - it's in Phase II testing right now. Just be prepared for a long haul, which isn't necessarily a bad thing.

I also mentioned that Genzyme (Nasdaq:GENZ) was more of a liability than an asset relative to other biotech opportunities, and I'm sticking to the argument. The stock's still trading at a twelve-month multiple in the low 40s, despite the 11% rally off of June's low.

A P/E reading in the 40s would be nothing for a biotech with a blockbuster pipeline. Genzyne's current projects are far from exciting to investors, though. It's got a pediatric leukemia drug called Clolar in the works, and an oral Gaucher's disease treatment also in development. Even the latest news about the cholesterol drug deal with Isis Pharmaceuticals (Nasdaq:ISIS) is far from riveting, as the FDA won't be evaluating the drug until 2010.

The Easy
Despite the disparity, I still like the way these stocks are collectively finding themselves on firmer footing. Even the names I find a little troubling are seeing their shares move a little higher. If picking an individual biotech stock isn't your thing, there's always an exchange-traded fund. I already mentioned the Biotech HOLDRs, but the iShares NASDAQ Biotech ETF (AMEX:IBB) could deserve some attention too.

For more on evaluating pharmaceutical companies, check out Measuring The Medicine Makers.

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