Source: Federal Reserve Bank of New York.
With the exception of the last couple of weeks, the biotech sector has been a vast outperformer since the Great Recession. The broad-based S&P 500 has pretty much tripled since hitting its lows in March 2009, while the SPDR S&P Biotech ETF (XBI +0.23%) is up a whopping 425% over that span.
With the stock market correction recently pushing the SPDR S&P Biotech ETF down 15% from its recent highs you might be under the impression that there are some great deals to potentially be had -- and you'd be correct. However, not every biotech stock looks like a screaming value. In fact, three of the sectors' 11 largest companies by market value appear to be downright expensive.
Incyte (INCY +1.27%): $21 billion market valuation
If there's a large-cap biotech ($10 billion valuation of higher) with a valuation that should terrify value investors, I'd say it's Incyte.
Incyte's claim to fame is Jakafi (known as Jakavi in overseas markets), a JAK2 inhibitor designed to alleviate the symptoms of patients with myelofibrosis, a rare condition that leads to scarring of a patient's bone marrow. Incyte's therapy is the only one currently approved by the Food and Drug Administration to treat myelofibrosis, and it led to a greater number of patients experiencing at least a 35% decrease in spleen size relative to the placebo in clinical trials.
Source: Incyte.
However, Incyte's therapy has one fatal flaw: it led to no objective responses in clinical trials. JAK2 inhibitors only appear to alleviate some of the symptoms associated with the disease rather than attacking its root cause. But imetelstat, a drug being developed by Geron, which in turn is partnered with Johnson & Johnson, did demonstrate objective responses in early stage clinical studies.
In an early stage investigator-sponsored trial with the Mayo Clinic, imetelstat generated an overall response rate of 41%. Furthermore, a recent phase 2 study published in The New England Journal of Medicine noted that imetelstat led to "unprecedented complete and partial remissions." Long story short, Incyte's revenue stream could be in big trouble.
In Incyte's defense, it has a small army of JAK- and IDO1-based solid tumor targets that, if successful, could generate a substantial amount of sales and profits. Unfortunately, if Geron's myelofibrosis therapy unseats Incyte's Jakafi it could push Incyte's bottom-line decidedly into the red until its cancer pipeline matures. For this reason, I'd suggest that Incyte's current valuation appears to be extremely aggressive.
Vertex Pharmaceuticals (VRTX 0.78%): $29 billion market valuation
Unlike Incyte, Vertex Pharmaceuticals can somewhat back up its mammoth $29 billion valuation thanks to its premier position in treating cystic fibrosis. Cystic fibrosis, or CF, is an orphan disease (a disease that affects fewer than 200,000 people in the U.S.), meaning Vertex has protection from generic competition and can charge quite a hefty annual price for its two approved CF-treatments, Orkambi and Kalydeco. Orkambi boasts an annual cost of $259,000, while Kalydeco clocks in at nearly $300,000.
So why should investors be skeptical?
Source: Vertex Pharmaceuticals.
First, Vertex isn't a cheap company. It's expected to lose more than $1 per share this year, and it's valued at close to 30 times forward earnings. If you look further out (say 2018), then its forward P/E makes more sense based on its current valuation. However, it's still trading at more than six times its projected sales in 2018 based on Wall Street's estimates. With a number of biotech buyouts occurring at roughly three times the peak sales estimates of a company's portfolio, Vertex appears aggressively valued on a fundamental basis.
Secondly, Vertex's pipeline revolves around CF. With the exception of a handful of relatively early stage oncology products, Vertex is reliant on Orkambi and Kalydeco, which could leave it exposed to significant downside if a competing therapy eventually does emerge.
Lastly, investors should keep in the back of their minds the possibility that Congress may tackle prescription drug price reform. Orkambi and its $259,000 price tag could stand out as the poster child for reform, and any pricing curbs that could be put in place could squarely affect Vertex's profitability.
In my opinion, Vertex Pharmaceuticals appears to be fully valued here.
Biogen (BIIB +1.11%): $70 billion market valuation
Finally, I even have some skepticism surrounding the valuation of one of biotech's blue-chip stocks, Biogen.
Source: Biogen.
One front-and-center concern for Biogen investors has to be the slowing growth of Tecfidera, an oral therapy designed to treat relapsing forms of multiple sclerosis. Tecfidera sales climbed to $883 million in the second quarter from $700 million in the previous year, but sequential quarterly growth slowed to just 7%. Increasing competition in the relapsing-MS space along with market saturation are pushing Tecfidera nearer to its sales ceiling. Without Tecfidera's lightning-fast growth, Biogen investors may begin to look elsewhere.
Another worry is that a lot of premium has been pumped into Biogen's valuation on the heels of two potential blockbusters: aducanumab for Alzheimer's and anti-Lingo-1 for multiple sclerosis and acute optic neuritis. Alzheimer's is an indication that has a particularly poor track record of success in clinical studies regardless of company size. When Biogen updated its phase 1b results involving aducanumab in July we learned that the benefits provided by the 3 mg and 10 mg dose weren't as different statistically from those offered by the placebo as first suspected.
Additionally, in the RENEW study for acute optic neuritis, anti-Lingo-1 missed its secondary endpoints. This may have been due to retinal ganglion cell layer thinning before the administration of anti-Lingo-1, but it nonetheless was a bit of a disappointment. If either of these potential blockbusters fails to live up to the hype, Biogen's stock could have quite a ways to fall.
