Small Caps | Dec 13 2011
– Oz life sciences stocks have underperformed this year
– Sector still in an uptrend according to Bell Potter
– This suggests upside once market conditions improve
– Bell Potter outlines its preferred plays in the sector
By Chris Shaw
The last seven months have not been kind to Australian life sciences stocks, as Bell Potter's Life Sciences Index has fallen 28% to 76.3 points since May 10 this year. This compares to a 10% fall in the All Ordinaries Index over the same period.
The stockbroker's Life Sciences Index is an equally weighted index of 71 ASX-listed stocks. Having calculated the index back to December 1999, Bell Potter makes two main conclusion. The first is the Life Sciences sector tends to enjoy multi-year trends.
The second finding is despite recent weakness the current trend is bullish and could extend until possibly 2013 in the broker's view. Relative movements support this, as while over the past eight years the All Ordinaries has gained 37% the Life Sciences Index is still 50% below its high of August 2003.
Bell Potter attributes this underperformance to two factors. First, the global debt crisis has reduced the risk tolerance of investors, meaning less interest in the more speculative end of the market. As well, a number of the life sciences companies have disappointed the market in terms of announcements with respect to development progress.
Despite the recent poor performance, Bell Potter sees the sector as well placed to recover as the market comes out of its present period of weakness. News flow should be strong for many companies in the sector over the next 12 months, while fundamentals for most companies are largely unrelated to current economic conditions.
One basic thesis for the sector suggested by Bell Potter is the benefit of the survival of the fittest nature of the market. Post the GFC and a generally poor period from 2007-2009, biotech and medical device companies have performed strongly over the past couple of years.
This reflects a maturing in the sector in Bell Potter's view, with products and technologies now at later stages of development and being better understood by investors in the marketplace. As well, life sciences companies in Australia are now being better managed.
While there is upside potential, Bell Potter acknowledges the life sciences sector is not without risk. As an example the broker points to Pharmaxis ((PXS)), where a negative ruling on its Bronchitol drug cut market value by 74% in a day, only for the decision to later become a positive one.
But with these risks come potential rewards, Bell Potter noting for the 15 biotech and medical device companies under coverage, the average price target upside from current levels is 205%. These targets are based largely on clinical progress expected over the next 12 months.
With respect to clinical results, Bell Potter notes the success rate for biological drugs is now about one-in-three. This means the cost of clinical failure has fallen in recent years, which in turn means companies are not as impacted financially by the failure of a clinical development program.
Another key driver is the fundamental need for big and specialty pharma to acquire new compounds to feed drug pipelines, especially given low research and development productivity. This is happening at the same time Big Pharma is falling over the cliff in terms of patent expiries and as drug development costs are increasing.
This is likely to see M&A activity remain a feature in the sector, as acquisitions can bring late stage drug candidates with lower levels of risk and help freshen product life. As well, Bell Potter notes acquisitions can come more cheaply than internal research and development.
In terms of preferred sector exposures, Bell Potter has seven stocks it particularly likes. These include Bionomics ((BNO)), GI Dynamics ((GID)), Phosphagenics ((POH)), Mesoblast ((MSB)), REVA Medical ((RVA)), Starpharma ((SPL)) and QRxPharma ((QRX)). All are rated as Speculative Buy.
The attraction of Bionomics is two potential blockbuster drugs, one the anti-anxiety compound BNC210 where outstanding Phase Ib/IIa clinical data has been received. The other positive with Bionomics is a strong technology platform, which has delivered a number of valuable pipeline opportunities according to Bell Potter.
Potential in the diabetes and obesity markets are the attraction of GI Dynamics, given the upside on offer from the group's EndoBarrier product. Strong news flow should keep investor attention, especially as Bell Potter notes the EndoBarrier product works better than comparable therapies.
For Mesoblast, Bell Potter sees upside from stem cell technologies that work, as evidenced by Phase II data in heart failure the broker regards as outstanding. Given large cardio therapy markets the share price should benefit from further good trial news in the broker's view.
Phosphagenics offers a transdermal drug therapy that works, Bell Potter noting as an example the company is well placed to develop the world's first patches for the analgesic drug oxycodone. This represents a US$3 billion market in the US alone.
For QRxPharma the MoxDuo drug combination offers investors a late stage opportunity as the drug is near to being released to what is a large and growing pain relief market. Bell Potter suggests the current share price undervalues the upside potential available in QRxPharma.
REVA offers an opportunity in bioresorbable stents, a product Bell Potter suggests could reinvigorate the stent category. This leaves REVA well placed to be a target of M&A activity, while a timetable slippage suggests value at present in the broker's view.
Starpharma should enjoy a strong royalty flow once its VivaGel related condom royalties begin next year. Bell Potter sees additional upside potential given Phase III trials of its bacterial vaginosis product beginning in 2012.
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