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3 Stocks to Avoid in Biotech

By Cory Renauer, Keith Speights, and George Budwell – Updated Oct 28, 2016 at 2:08AM

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Buying biotech stocks has always been a risky business, but these three are best left on the shelf.

Image source: Getty Images.

Public outrage over escalating drug prices made the biotechnology industry generally toxic to plenty of portfolios to begin the year, and fear of political backlash isn't helping. The iShares Nasdaq Biotechnology index, which tracks over 180 biotech stocks listed on the exchange, is still down about 22% for the year, while the broader S&P 500 benchmark has notched a near-5% gain.

Politicians have been threatening to enact drug pricing controls for decades, and the barks have consistently been worse than the bites. This makes the biotech industry a great place for long-term-minded investors to find bargains.

Not every beaten-down biotech stock is a buy, though, and some should be left alone at any price. Three Motley Fool contributors are avoiding MannKind (MNKD -1.24%), Sarepta Therapeutics (SRPT 1.41%), and Novavax (NVAX 4.86%) like the plague. Read on to find out why.

A biotech tragedy

Keith Speights: If Shakespeare were alive and writing about biotech stocks, we'd probably have a play about MannKind. And it would definitely be a tragedy.

About the only positive thing that has happened to MannKind in the last few years was its finally winning approval for its inhaled insulin, Afrezza. It's been all downhill since then. Sanofi (NYSE: SNY) abandoned commercialization of Afrezza after an unsuccessful launch. Founder Al Mann passed away in February. Shares of the biotech have plunged nearly 64% in 2016. That's on top of a 74% drop last year.

Image source: Getty Images.

What's next? MannKind is getting low on cash. It may have enough money to fund operations for another six months, and it can borrow an additional $30.1 million under a previous loan arrangement with The Mann Group. MannKind's other main avenue of raising cash is to issue more shares, which would dilute the value of existing shares that have already lost much of their value.

At this point, MannKind is clearly a stock to avoid. I'm afraid no one will be saying "all's well that ends well" about this biotech a year from now.

This rare-disease drugmaker may have already peaked

George Budwell: Sarepta Therapeutics' stock has risen more than 138% in the last three months following the Food and Drug Administration approval of its Duchenne muscular dystrophy (DMD) drug, Exondys 51. However, the market may have gotten a tad carried away. After all, Sarepta's shares spiked before the drug's price was even announced -- and before insurers made their thoughts known on the all-important issue of coverage. And neither of these key issues has played out the way shareholders had originally hoped.

Analysts were forecasting an annual wholesale price in the neighborhood of $550,000, prior to Exondys 51's approval. Sarepta, however, ended up significantly undercutting this estimate by pricing a year's supply of the drug at $300,000. As an added headwind, Anthem (NYSE: ANTM), the second-largest health insurer in the U.S., recently announced that it would not cover Exondys 51 due to outstanding concerns about the drug's effectiveness. The underlying issue is that Exondys 51's accelerated approval was based on a controversial study of only 13 patients that essentially left the FDA's internal reviewers questioning the drug's ability to actually improve patient outcomes. As such, Anthem doesn't believe this pricey rare-disease drug warrants coverage right now.

The net result is that Sarepta's shares are currently trading at approximately 14 times projected 2017 revenue, which certainly qualifies as a stretched valuation. So, unless a buyer steps in to gobble up this rare-disease drugmaker -- and that's always a possibility when it comes to orphan-drug companies -- there's a fairly strong chance that this stock will give back a good portion of these recent gains soon.

Ticking time bomb

Cory Renauer: A not-so-shocking phase 3 failure smashed into Novavax like a milewide asteroid last month, but that hasn't stopped some investors from wondering if the company can salvage anything from its lead program. Its only candidate in late-stage clinical development was, and still is, a long-awaited vaccine to prevent respiratory syncytial virus. RSV is a relatively benign disease for healthy adults, but it nonetheless leads to more than 1 million medical interventions in the U.S. each year.

The company's RSV F Vaccine was the first to show a less-than-airtight yet statistically significant benefit for older adults in a 1,600-patient clinical trial. Unfortunately, Novavax shareholders learned some expensive lessons about statistics and biotech investing when it announced a dismal failure in an 11,850-member phase 3 trial with similar patients.

The clock is ticking for Novavax in more ways than one. It finished June with $366.4 million in cash and marketable securities to work with, but it's also running a trial with 8,255 pregnant women to see if its vaccine might benefit their babies. Follow-up testing thousands of patients is costly, and the company burned through $156.6 million in the first half of the year. Now that the trial in older adults is finished, Novavax's cash burn rate should subside, but without any products to sell, it's walking on thin ice.

While RSV infection is the second-largest cause of infant mortality worldwide and the leading cause of infant hospitalizations in America, the odds of success in the big maternal vaccination trial are terribly long. In the failed phase 3 trial, a slightly higher percentage of older adults injected with the vaccine became infected than those receiving a placebo.

Image source: Getty Images.

The debt Novavax used to pave its cash runway is another concern. In January, the company borrowed $325 million in the form of convertible notes due fewer than seven years from now. With its stock price depressed, raising equity to develop some early-stage vaccines in its pipeline would lead to huge dilutions, and I doubt potential lenders will be eager to answer the company's calls going forward.

Granted, there's a minuscule chance that Novavax can unearth a nugget of hope from the failed phase 3 trial data, but the recent rescheduling of its annual investor meeting from Oct. 7 to Nov. 9 doesn't bode well. If its RSV program is a total bust, Novavax won't have a product to sell for years at best. That's why I wouldn't touch this biotech stock with a hazmat suit on.

Cory Renauer has no position in any stocks mentioned. George Budwell owns shares of iShares NASDAQ Biotechnology Index. Keith Speights has no position in any stocks mentioned. The Motley Fool recommends Anthem. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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