It’s not over for biotech until the fat lady sings, and she’s just getting into the second act, at least according to Yaron Werber, M.D., Managing Director at Citi Research. In a research report on the biotech sector published March 12th, Werber and colleagues suggest that although valuations are starting to approach expensive, productive innovations and a more cooperative FDA means there’s still more upside for biotech.
Strong sector fundamentals
The report begins by highlighting the strong performance of the biotech sector over the last few years and in 2013. “Large cap biotech did very well [in 2013] driven by new products/pipeline, upwards EPS revisions, favorable pricing environment, and solid growth in a low growth global macro environment.”
The trend has continued in 2014, with the Russell 2000 Biotech Index up 21% for the year, while the Russell 2000 Index is just up 3% and the S&P 500 Index is up 2%.
Biotech likely to remain strong until macroeconomic environment improves
Werber et al also anticipate that the biotech sector will continue to show strength for a few quarters, but ae likely to suffer from sector rotation in the not too distant future. They argue biotech will continue to be perceived as an attractive investment until the overall economy picks up. “While the fundamentals are better than the S&P500, we anticipate that generalists will move away from biotech to other sectors when the macro environment improves. Until then, large-cap biotech will continue to post solid gains, but even large cap valuations are getting stretched.”
Possible slowdown in M&A
While remaining bullish on the sector as a whole, the Citi analysts do caution that a slowdown in M&A activity is possible due to the increasingly high valuations of biotech concerns. They also anticipate fewer IPOs this late in the sector economic cycle. “IPO environment should cool off as investors have become more valuation sensitivity and more aware of high risks for early stage biotechs.”
