If you were looking for a hot sector to buy at the beginning of 2013, biotech was it. The iShares Nasdaq Biotechnology ETF (NASDAQ: IBB ) has soared more than 56% this year with only a few weeks to go. With biotech sizzling, you might think it would be hard to find an undervalued stock in the pack. Actually, that task isn't too hard.
Of course, there's a difference between cheap and undervalued. For example, PDL BioPharma (NASDAQ: PDLI ) looks really inexpensive. The problem, though, is that the company's revenue is on track to begin drying up quickly with patents for its primary products expiring at the end of 2014. PDL is cheap, but I wouldn't say the stock is really undervalued considering the uncertainty that lies ahead.
There is a biotech, however, that could very well deserve the title of most undervalued in 2013. Questcor Pharmaceuticals (NASDAQ: QCOR ) trounced the high-flying iShares Biotech ETF, with shares doubling year to date. Even with this major surge, Questcor sports a trailing price-to-earnings ratio of only 12. The company's forward P/E of below 8 looks even more attractive.
To best understand why Questcor has done so well but is still so inexpensive, we need to look back over the past year. Investors were scared in February after the company reported fourth-quarter 2012 results that showed declining sales for Acthar in treating multiple sclerosis. Sales for the indication had consistently climbed every quarter for five years, so an 8% drop nearly seemed like a sign of the apocalypse.
Yet another seeming signal of doom came a couple of months or so later when Questcor announced its first-quarter results. This time around, it wasn't just the multiple sclerosis indication that was problematic. Total shipments for Acthar fell for the first quarter in years. However, Questcor suspected that seasonality was a factor as well as its launching of a new reimbursement support center.
That suspicion appeared to be validated in the second quarter. Questcor blew away all revenue and earnings expectations. Contribution from a new sales push for rheumatology helped significantly. CEO Don Bailey said that the rheumatology launch was the best for a therapeutic area in company history.
Those winning ways continued into the third quarter. Questcor yet again knocked the ball out of the park with record sales and earnings. But that's when fears resurfaced about another possible dark cloud on the horizon.
Back in 2012, Questcor revealed that the U.S. attorney's office for the Eastern District of Pennsylvania was investigating the company's promotional practices. In October of this year, it was reported that the U.S. attorney's office for the Southern District of New York and the Los Angeles office of the SEC were joining that investigation. Since then, shares have declined nearly 25%.
Largely because of the concerns about this investigation, Questcor's valuation is one of the lowest among biotech stocks. There are likely also some latent worries that payers will cut back on reimbursement for Acthar, although that hasn't proven to be a serious issue for Questcor so far.
Biotech's big run in 2013 narrows the list of low valuation stocks considerably. Anika Therapeutics (NASDAQ: ANIK ) looks inexpensive when you look at its P/E-to-growth, or PEG, ratio, which stands at a low 0.73. However, Anika isn't so attractive without factoring in growth potential. Its trailing P/E is 27.
Actually, from a PEG perspective, there are only a couple of biotech stocks in the same league as Questcor. PDL BioPharma's PEG of 0.33 is lower than Questcor's 0.40. However, we already noted the issues surrounding PDL.
China Biologic Products (NASDAQ: CBPO ) boasts a PEG of 0.45. That's just a little higher than Questcor's. But China Biologic's trailing P/E of 17 is considerably higher than Questcor's multiple. The company also only barely increased revenue in the last quarter, whereas Questcor grew year-over-year revenue by nearly 70% in the third quarter.
It remains to be seen what the outcome of the investigation into Questcor's marketing practices will be. That uncertainty could dampen the stock's prospects for a while. However, I suspect that Questcor will keep chugging along with impressive sales of Acthar, especially as it expands into new indications. My vote is for Questcor as the most undervalued biotech stock of the year.
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