10 Most Profitable Businesses in Biotech

Source: Food and Drug Administration, Facebook.

The biotech sector is rife with hits and misses, perhaps more than any other sector.

Instead of profits being the primary driver of valuations within the biotech sector (since most companies are still losing money while developing their first or second drug), the peak sales potential of a drug and the estimated number of people a developing drug could help are often what investors use to determine an appropriate market valuation.

In far fewer instances, though, profits do matter within the biotech sector. Out of 157 biotech companies valued at $300 million or more, just 28 are currently profitable on a trailing 12-month basis, per Finviz's data. However, for companies that are profitable, the returns can be enormous.

Why? Because innovator drugs, also known as branded drugs, are typically protected from generic competition for a number of years, and thus usually have healthy price points that can sometimes lead to gross margins in excess of 70%, 80%, and in rare cases even 90%! If you are able to latch onto a biotech company with superior margins, you can make a lot of money in the process.

With that in mind, let's take a closer look at the 10 most profitable businesses in biotech.

10 most profitable businesses in biotech
For this search I focused strictly on biotech businesses above $300 million in value in order to eliminate thinly traded stocks or companies not on reputable exchanges. Biotech stocks that received a large one-time payment but are without a clinically approved product were removed as well.

In order to gauge biotech businesses' profitability we'll be utilizing profit margin, since this figure takes into account how much net profit is left over as a percentage of revenue after accounting for costs of goods sold and operating expenses. It's a fairly accurate method of analyzing the health of a business.

Here are the 10 most profitable businesses in biotech as ranked by profit margin percentage:

Source: Finviz.

These aren't slam-dunks
It's important that investors realize a high profit margin isn't in itself going to guarantee a successful investment. There are other factors that should be taken into account when examining the most profitable businesses in biotech.

Source: PDL BioPharma.

For example, PDL BioPharma isn't a traditional biotech company. Its business is based on purchasing royalty-based assets. The advantage to this model is it's very low cost to maintain (beyond the royalty right purchases), and thus leads to few overhead costs and high margins. Unfortunately, PDL's assets only have a finite period of patent protection. The company's Queen royalties, which supply a majority of its royalty revenue, expired in December. Once final inventories of drugs bearing PDL's Queen royalties are sold, which will take about a year or perhaps a little more than a year, PDL will likely see more than half of its revenue evaporate on a year-over-year basis. In other words, PDL's profit margin probably isn't sustainable.

Targeted and rare-disease drugs
Drug developers that target a specific disease, or which focus on rare diseases and disorders, are also prone to high profit margins. The reason is orphan and targeted drug developers can usually charge pharmacy-benefit managers and insurers a five- or six-digit annual price tag and get away with it since there are likely few competing therapies available.

Source: Alexion Pharmaceuticals.

Alexion Pharmaceuticals, for instance, markets Soliris as its only drug. Soliris treats two rare diseases: paroxysmal nocturnal hemoglobinuria and atypical hemolytic uremic syndrome. Prior to Soliris there was no drug targeted at either disease. As such, Soliris is the most expensive drug in the world, with an annual cost approaching $537,000 per year. With little competition on the horizon for Soliris, Alexion can simply sit back and let the profits stream in. Truly, the only major concern for Alexion would be the small possibility of Congress enacting some form of pricing controls on the pharmaceutical industry.

By a similar token we have Medivation, which, in partnership with Astellas Pharma, has delivered advanced prostate cancer drug Xtandi to market. Demonstrating superior results in post-chemotherapy and pre-chemo settings compared to prior standards of care, Xtandi sales could realistically double between 2014 and 2017. Unless a new advanced prostate cancer treatment blindsides the market, Medivation and Astellas' market share with Xtandi is likely safe -- as is Medivation's hefty profit margin.

The cream of the crop
But when it comes to the most profitable businesses in biotech, even if they're not No. 1 in total profit margin percentage, Gilead Sciences and Biogen are the cream of the crop!

The two offer what are arguably some of the deepest existing product and experimental drug portfolios in the biotech industry.

Source: Gilead Sciences.

In the case of Gilead Sciences, it has two relatively new hepatitis C therapies (Sovaldi and Harvoni) which have dramatically boosted HCV cure rates into the 90-percentile while also reducing the severity of side effects when compared to previous standards of care. Sovaldi and Harvoni are also once-daily pills, reducing the need to take multiple medications and improving patient convenience and adherence.

On top of its HCV dynamic duo, Gilead Sciences also has several blockbuster HIV/AIDS drugs, including Stribild, which eliminated all detectable traces of the HIV-1 virus in a late-stage clinical trial at the 48-week mark. Gilead also boasts a deep liver disease pipeline that's targeting hepatitis B and nonalcoholic steatohepatitis, or NASH, a disease affecting millions of people in the United States. Gilead will likely remain a cash flow monster for years to come, and its recently instituted dividend is evidence to that.

Source: Alzheimer's Association, Facebook.

Biogen's product portfolio is a bit more focused. You might even say the company has drawn a bullseye and built a great wall around the multiple sclerosis indication, since its MS drugs Tecfidera, Tysabri, Avonex, and Plegridy account for a substantial amount of MS-based market share. But Biogen may have a few other tricks up its sleeve to keep the billions rolling in.

In a phase 1b trial targeted at Alzheimer's disease patients, aducanumab (previously known as BIIB037) led to a pronounced degree of beta amyloid removal -- beta amyloid is the plaque that sticks to our brains and progressively disrupts cognitive function -- and a substantial improvement in two cognitive function tests. The results were so impressive that aducanumab skirted right past phase 2 studies and was hustled directly into a larger phase 3 program. If approved, aducanumab is estimated to have sales potential approaching $10 billion per year at its peak. 

If I'm placing my bet on a biotech company and utilizing profit margin as a decisive tool in my analyzing process, a diverse biotech company like Gilead or Biogen is most likely to hold my attention.