Investors have been taken for quite the wild ride in 2016. Stocks opened the year with the worst two-week start in recorded history and followed it with the most voracious intra-quarter rally since 1933. However, the biotech sector has missed out on the stock market's march to all-time highs.
The SPDR S&P Biotech ETF (NYSEMKT:XBI) is down 18% year to date, while the broad-based S&P 500 is up nearly 6%. That's a pretty awful performance from an industry that should be benefiting from low yields and access to cheap and plentiful capital.
The fact that biotech stocks are down for the year could signal that investors simply aren't willing to pay as much of a premium for the potential reward that biotech stocks offer. The vast majority of biotech stocks have pipelines that show promise, but most are also losing money. In many cases, biotech stocks are reliant on just one or two experimental therapies -- and when the stock market begins to get volatile, investors lose their willingness to take on the risks associated with holding these narrow pipelines.
These three biotech giants could be headed for earnings revisions
Both Gilead and Alexion are healthfully profitable companies. Meanwhile, though BioMarin is losing money, it does have five rare-disease drugs on pharmacy shelves that are approved by the Food and Drug Administration. Unfortunately, I suspect the earnings estimates for all three of these biotech giants could be pushed lower for the remainder of 2016, and perhaps for 2017.
Why, you ask? Look no further than Britain's decision to the leave the European Union, commonly known as "Brexit." While the possibility of Brexit was always on the table, few pundits actually believed British citizens would opt to leave the EU. The reaction in global markets was swift, but stock markets have since recovered. Yet the British pound and the euro, which are now viewed as weaker currencies, have not enjoyed such a recovery.
Of the largest biotech companies you can buy that also disclose their financial exposure to Europe, Alexion, BioMarin, and Gilead have the highest European sales exposure. According to data compiled by Bloomberg, Alexion gets 32% of its sales from Europe, BioMarin gets 27%, and Gilead Sciences gets about 21%. Because all three of these companies report their revenue and profits in U.S. dollars, it means they have to convert a considerably devalued British pound, or a modestly devalued euro, back into a stronger dollar. In other words, Alexion, BioMarin, and Gilead will lose sales and profits in the currency translation process.
If there is some solace here, it's that Britain doesn't comprise a huge percentage of sales for any of these three companies, so the nearly 15% decline in the value of the pound versus the dollar since Brexit won't be a huge factor. But a roughly 2.5% move lower in the euro against the dollar, coupled with the small percentage of revenue these companies derive from the U.K., could easily result in a low- to mid-single-digit drop in 2016 full-year EPS for all three companies.
Have no fear -- operating results are here!
Though earnings revisions seem likely for Gilead, Alexion, and BioMarin, smart investors should be able to look past the smoke-and-mirrors adjustments that currency translation can cause and instead focus on the meat and potatoes of these biotech giants' business models. In other words, investors should be focused on operating results -- and they shouldn't be disappointed.
For instance, even though Alexion disappointed investors by reporting in early June that its late-stage REGAIN study -- which examined Soliris as a treatment for patients with refractory generalized myasthenia gravis -- failed to meet its primary endpoint, this hasn't slowed Soliris' growth one iota. Approved as a treatment for the rare diseases paroxysmal nocturnal hemoglobinuria and atypical hemolytic uremic syndrome, Soliris, along with Kanuma, should help push Alexion's sales higher by 20% annually over the next four years. On an operating basis, Alexion is in great shape.
Gilead Sciences may no longer be knocking the socks off growth investors, but it's still delivering incredible cash flow on account of its hepatitis C and HIV product portfolio. Gilead currently maintains more than 90% market share in hepatitis C, and that could expand further with the recent approval of Epclusa, the first pan-genomic HCV treatment. Gilead genuinely looks capable of generating $15 billion or more in free cash flow every year. A small decrease in EPS from currency translation can easily be overlooked by smart value investors.
Even BioMarin, which is forecast to lose money through 2018, should be able to fight through the challenges of a weaker pound and euro. Because BioMarin focuses on extremely rare diseases (like Alexion), it tends to avoid competition and has excellent pricing power. Wall Street is currently forecasting that BioMarin's sales will double from the $890 million it reported in 2015 to an estimated $1.9 billion in 2019. With another six unique therapies in clinical trials, BioMarin could still reward investors.
Long story short, prepare for likely earnings revisions but remember to focus on the far more important operating performance of these biotech giants.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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