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Analysts Talk Hot Biotech Stock Picks

 


By Hal Plotkin
Silicon Valley Correspondent

Dain Rauscher Wessels initiated coverage of 11 biotechnology stocks last week saying several of them could move up 50 percent or more in price over the next 12 months. But leading industry analysts say two lesser-known biotech firms appear to have even hotter hands.

The biotech sector has been a star performer in this year’s otherwise dreary stock market. The BioCentury 100 index, which tracks the performance of the top 100 biotech firms based on market capitalization, is up 72 percent for the year to date through Aug. 31 and up an even more-impressive 138 percent since Sept. 1, 1999.

By contrast, the Nasdaq Composite and the Standard & Poor’s 500 stock index, were both up just 4 percent for the year to date through Aug. 31.

Dain Rauscher Wessels analyst Todd Nelson is among those who say the biotech party isn’t over yet. His recent initiation included three stocks that he expects to move up quite sharply over the next 12 months: Affymetrix, Incyte Genomics and Nanogen Inc.

Opinions, however, are divided on some of those picks, with other analysts saying parts of the volatile biotech sector, especially the so-called biotech toolmakers that are among the stocks Nelson favors, may already have gotten ahead of themselves.

“The attention the toolmaker companies are now getting is sort of fascinating,” says Jim McCamant, publisher of The Medical Technology Stock Letter, based in Berkeley, Calif. “But we think people have already expanded the potential of the tool companies. The new price targets being set are mostly below their all-time highs, so that tells you something. Right now, I’d be looking at firms that are going to be bringing important new products to market. I think that’s where you’ll see the biggest moves.”

McCamant is a veteran biotech stock picker with one of the best track records in the industry. His model biotech portfolio, which was up 69 percent last year, has increased 746 percent since he initiated coverage of biotech stocks in 1987. His aggressive biotech portfolio has fared even better, up 197 percent last year and up nearly 2,500 percent since 1987, as of the end of June 2000, which was before much of the most-recent round of price escalations took place.

“In general, biotechs have done extremely well this year, so buying in now seems, shall we say, an interesting proposition in general,” says Karen Bernstein, the editor of BioCentury, a well-respected Belmont, Calif.-based trade publication. “On the other hand, the industry is in the best shape it has ever been in, it raised over $27 billion in the first three quarters of this year, which is already four times more than it raised in all of 1996, the best previous year on record.”

“The industry has the tools, and it has the money,” Bernstein adds. “Now they just have to go do it.”

Scott Greenstone, an analyst at Thomas Weisel Partners in New York, says biotech investors would be well advised to keep their seatbelts fastened no matter which stocks they might pick.

“Investors understand these stocks have legs,” Greenstone says. “They know we are at the very beginning of the new drug development revolution. The stocks run up, people take their profits, and then get back in. I think the roller-coaster ride will continue. But years from now a smart buy-and-hold biotech strategy should make you a very wealthy person.”

Here’s a rundown of the biotech stocks that Dain Rauscher Wessels says have some of the biggest upside potentials within the sector over the coming year, as well as two other biotech stocks not covered by the firm, ICOS and ImClone that other analysts say could make an even bigger splash in the coming months.

Affymetrix Inc. {AFFX}
Biotech toolmaker Affymetrix is the leading supplier of high-density microarray technologies used to enable drug discovery and development. High-density refers to the ability of the technology to screen and identify a larger number of biological samples in each run, as compared with less-powerful low-density techniques.

As such, Affymetrix is often the technology of choice in the early and most-costly stages of drug-candidate investigations when researchers seek to cast the widest possible net.

Analysts say Affymetrix faces much less competition than many other biotech firms offering similar low-density products, which are already well on their way to becoming commodity items.

Nelson has a $112 12-month price target on the stock, which he says is based on 25 times his 2001 revenue estimate of $276.3 million.

“Affymetrix is clearly the dominant player in DNA microarrays,” says Alfred Mansour, Ph.D., chairman and CEO of BiotechWatch.com, an online service based in Franklin, Mich., that tracks the progress of biotech firms.

“Affymetrix’s business model and strategy have made their arrays the gold standard in genomic research in both academic and industrial settings,” Mansour says.

Mansour adds that the company faces a challenge, though, in reducing the cost of producing and using its microarrays so they can be more widely applied not only in research settings but also in more-lucrative diagnostic markets.

In addition, Mansour notes that the company faces more-intense competition in the future from the likes of Corning Inc. {GLW} and Motorola Inc. {MOT}, both of which recently announced their intentions to enter Affymetrix’s high end of the microarray market.

McCamant warns that competitive forces could deal some crushing blows to Affymetrix investors.

“To me it seems pretty clear that Affymetrix is overvalued,” McCamant says. “They have an interesting but very expensive technology. They’re going to have to find a way to do it cheaper, or they won’t have much of a market left at all.”

The company is also in the midst of a patent dispute with U.K-based Oxford Gene Technology, which won an important round in its legal battle with Affymetrix earlier this year.

“Few people seem to be paying attention to the patent issue,” Bernstein says. “But it could be a very big deal.”

“Patent lawsuits go on forever,” Greenstone counters. “The litigation issues do raise the risk profile, but my belief is they will ultimately be settled, although it is a question mark in the near term. I still like the stock. They have 90 percent of the market for DNA chips.”

Greenstone’s current price target on Affymetrix stock, which he rates “buy,” stands at 110. He says near-term concerns are the only reason the stock doesn’t carry his more-enthusiastic “strong buy” recommendation.

Incyte Genomics Inc. {INCY}
Formerly known as Incyte Pharmaceuticals, Incyte Genomics provides its customers, mostly large drug companies, with access to its proprietary database on a subscription basis, which creates recurring revenue. Its LifeSeq database, for example, links biological data with genetic information to aid drug discovery.

Incyte’s emphasis is shifting, Mansour says, from data mining to the development of proprietary software tools and systems to analyze genomic information. This shift is illustrated, he says, by the development of Incyte’s Genomics Knowledge Platform and a recent collaborative agreement with International Business Machines Corp. {IBM}.

Nelson has a $63 12-month price target on the stock, which is based, he says, on 15 times his 2001 revenue estimate of $238.1 million. He sees the company as being able to defend its emerging position as a leading supplier to pharmaceutical, biotech and life-sciences markets.

“I think Incyte is a long-term attractive stock,” McCamant says. “Its competitor, Celera Genomics Group {CRA} doesn’t even have a real business plan to compete with it yet.”

Even so, McCamant says he thinks some of the bloom is coming off the genomic rose, at least for a database company such as Incyte, which is essentially a toolmaker. “We’re seeing a gradual movement away from the hype around genomics toolmakers,” he says. “They’ve already had a pretty good run.”

Nanogen Inc. {NGEN}
Nanogen’s first product, NanoChip, allows molecules such as DNA to be analyzed on a microchip. The company markets its system to customers involved in genomics and biomedical research and is developing other applications.

Competitors abound, but Nelson says Nanogen has a winning approach in a fast-growing market.

“Based on its novel, microelectronics-based, microarray technology, we believe Nanogen is poised to capture increasing share in the genomic drug discovery market,” he wrote in a recent report.

Nelson put a $35 12-month price target on the stock, based on 28 times his $22.8 million 2001 revenue estimate for the firm.

But once again, McCamant urges caution.

“Nanogen is another tool company that is probably already fully valued, if not a bit more,” he says. “A lot of people are doing arrays.”

While not assessing the specific merits of Nanogen’s approach, Bernstein agrees that cutthroat competition is emerging in its part of the biotech sector.

“You have some products that are better for some things than others,” she says. “But you have many products now that are good enough. So it can be hard to get people to switch if they feel they already can do what they need to do. As the industry matures, that makes it more difficult for the tool companies.”

On the other hand, both Bernstein and McCamant say two other biotech companies, ImClone Systems Inc. and ICOS Corporation appear to be on the verge of some very significant product breakthroughs.

ICOS Corp. {ICOS}
Eli Lilly & Co. {LLY} and ICOS are developing a drug designed to compete with Pfizer Inc.’s {PFE} Viagra to treat erectile dysfunction and female sexual dysfunction. The new compound, dubbed Cialis or IC351, is said to facilitate blood flow to enhance sexual response without some of the sometimes-unpleasant side effects that can be created by Viagra.

Viagra’s side effects, for example, can include disturbances in vision and other physical problems. While that hasn’t stopped millions of men, and some women, from using the drug, analysts say that if ICOS can deliver the same results with fewer side effects, the drug will be an immediate sensation.

“I think they’re going to be coming to market with it in the first quarter of next year,” McCamant says. “It appears to be a significantly superior product.”

“Side effects with a lifestyle drug such as Viagra are very important,” Bernstein adds. “It’s certainly not too late for a company such as ICOS. If they have a second in class product, but it’s the best in its class, it can win.”

ImClone Systems Inc. {IMCL}
ImClone’s lead cancer therapeutic candidate, C225, acts as a biologically specific inhibitor to an important molecular switch that regulates cell division and propagation. The company has already announced encouraging results in phase two clinical tests of the compound targeted at treating head and neck cancer.

McCamant says he expects to see the company win market approval for the compound from federal regulators during the first quarter of next year. “It looks like it’s going to be a blockbuster drug,” he says.

The company also announced a favorable response to treatment in all six of the first cases of colorectal cancer using the new therapeutic.

Robert Toth, a biotech analyst at Prudential Vector Healthcare in San Francisco, says that if ImClone’s compound wins Food and Drug Administration approval, its performance is likely to mimic that of other biotech stocks, such as IDEC Pharmaceuticals Corp. {IDPH}, Immunex Corp. {IMNX} and Medimmune Inc. {MEDI}, all of which soared fourfold or more after winning FDA approval for their compounds over the past few years.

Toth upgraded ImClone’s stock to “strong buy” from “accumulate” and set a 12-month $165 price target on the stock earlier this summer.

The analysts warn, however, that investments in biotech companies are fraught with risk given the possibility that unforeseen issues will cause drugs to be pulled from testing before they ever reach the market.

“That could always happen,” McCamant says. “But there’s been a lot of progress in this area, and ImClone’s results are very encouraging.”

“I think everyone on Wall Street has come to the conclusion there will be a huge market for this drug when it comes to market,” Toth says. “That’s why [the stock] already has a high valuation. But there are a limited number of investors willing to play in the space before final approval. It’s after final approval when you usually see the really big pops. I think that’s what we’re looking at for ImClone.”

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