Biotech investors are always looking for ways to reduce risk. One method is to focus on stocks with drugs that have come out of phase 3 trials with good news. With enough research, you can usually figure out the odds of approval from the Food and Drug Administration (FDA), and how large the market opportunity is. That's often a good time to buy an unprofitable biotech.

Aurinia Pharmaceuticals (AUPH -2.17%) is filing a new drug application for its lupus drug, voclosporin, later this year. And Immunomedics (IMMU) is waiting for the FDA to approve its drug for triple-negative breast cancer, sacituzumab govitecan. Both of these stocks appear undervalued, given the high likelihood of drug approval from the FDA and the market opportunity that lies ahead.    

DNA drug in a test tube

Image source: Getty Images.

Introducing a new drug for lupus

Aurinia Pharmaceuticals is currently valued at $2 billion, which is pretty cheap for a company that is bringing a potential blockbuster drug -- one estimated to bring in over $1 billion in annual sales -- to market. Aurinia's drug, voclosporin, was a home run in its phase 3 trial as a treatment for lupus nephritis, which affects an estimated 60% of lupus patients. There is currently no approved drug for lupus nephritis. 

Aurinia tested its drug in 357 people over 52 weeks. Voclosporin had 40% renal response rates, compared to 22.5% renal response rates with the current standard of care. One person died while taking the drug, compared to five deaths in the control group. The stock doubled on the news.    

The overall lupus market is currently dominated by Benlysta, a drug from GlaxoSmithKline (GSK 0.71%). Benlysta racked up $581 million in sales in the first three quarters of 2019. Glaxo is trying to expand its drug to the lupus nephritis indication, and ran its own phase 3 trial last year. Its drug had 43% renal response rates, compared to 32% in the control group.   

Aurinia has no other drugs in its pipeline, so it's a one-hit wonder. Speculation is rampant that many big pharmas would like to acquire the small biotech. The stock is up more than 170% over the last year. 

Solving the problem of triple-negative breast cancer

One type of breast cancer is more dangerous than the rest. It's called "triple negative breast cancer," and it affects about 10%-20% of breast cancer patients. Triple-negative breast cancer is a highly aggressive type of cancer that tests negative for estrogen receptors, progesterone receptors, and the HER2 protein. Most cancer drugs aim for one or more of those targets, so most cancer drugs are not very helpful against this type of breast cancer. 

Immunomedics specializes in antibody-drug conjugate (ADC) therapy. The biotech company designs molecules that target cancer cells and leave ordinary cells alone. Its lead compound, IMMU-132, is a drug for many cancers, including triple negative breast cancer. The FDA has awarded IMMU-132 its Breakthrough Therapy designation, for drugs that provide substantial improvements to the current standard of care for a serious medical condition. 

IMMU-132 is being tested in clinical trials as a third-line therapy for patients with triple-negative breast cancer -- reserved for patients who have already tried two different cancer therapies to no avail. In this difficult-to-treat group, IMMU-132 had a 34% objective response rate, which is considered very good. 

Seattle Genetics (SGEN), another company that specializes in ADC therapies for cancer, was so impressed with the data that it offered Immunomedics a $2 billion deal to license IMMU-132 in 2017. But the company's majority investor, venBio Select Advisors (now Avoro Capital Advisors), found the offer too low. There was a proxy fight, and Immunomedics founder David Goldenberg and CEO Cynthia Sullivan were forced to retire. Immunomedics retained control of the molecule.

 Immunomedics is down about 30% off its highs. Both the market and the company were shocked when the FDA failed to approve IMMU-132 last year. The agency cited no efficacy or safety issues with the drug -- only manufacturing issues at the plant where the drug was to be produced. 

Immunomedics has found a new manufacturing partner and has since refiled its Biologics License Application with the FDA. An independent analysis commissioned by the company reported that IMMU-132 could bring in over $3 billion a year if the drug is approved for triple-negative breast cancer, urothelial cancer, and lung cancer. The company's current market cap is $4 billion, so there is plenty of upside to be had.

Risks and rewards

Odds are high that the FDA will approve both voclosporin and IMMU-132 in 2020. The risk/reward ratio looks good, given the positive trial data and the huge market opportunity. Despite Aurinia's fantastic run-up last year, the market is still undervaluing the stock. A company with a blockbuster lupus drug should fetch more than a $2 billion market cap. 

Immunomedics is currently valued at $4 billion, about twice the size of Aurinia. Yet its market opportunity is even larger, with a cancer drug that might be used in multiple indications -- including triple negative breast cancer, a disease in dire need of new treatment options. Either of these stocks might well reward patient (and risk-tolerant) investors.