The Nasdaq biotech index lost 17.7 per cent from its peak on 25 February as hot money fled the sector, bringing back memories of the huge sector’s crash in the early 2000s and leading many commentators to warn of a bubble bursting in the sector.
Performance of indices in 2014
Source: FE Analytics
However, Borho managed the Biotech Growth Trust through the bubble and says these events have nothing in common; in fact, the sector remains cheap compared to its peers.
“People love to talk about a biotech bubble, but the people who talk about a biotech bubble weren’t around during the bubble when companies were trading on 120 times P/Es,” he said.
“But now we hear talk about a biotech bubble when profitable biotech companies are trading on 0.7 times their internal growth rates.”
Borho says that the reason for the recent sell-off was only partly sector-specific. The main reason is a market-wide repositioning into value stocks as high-growth areas sold off.
“In late March in the US there was a huge repositioning from growth into value stocks, a complete reversal,” he said.
“At the beginning I though biotech was on its own but then it was all of the large high-rising stocks in the market.”
“If you overlay the momentum index versus biotech it was identical sell-off, and a lot of funds were in the wrong position: long growth and short value.”
This analysis agrees with that of Russ Koesterich, global chief investment strategist at BlackRock.
Koesterich said: “Investors are moving out of many areas of the market that performed well last year. In particular, the Internet, social media and biotechnology industries are experiencing some notable weakness.”
“In many ways, it is not surprising that sentiment is shifting away from some of the growth segments of the market.”
“Valuations for these industries are starting to appear stretched (particularly for biotech and social media companies), and investors are starting to seek better opportunities elsewhere—specifically in some of the more value-oriented areas.”
“This shift actually seems appropriate to us, as there are more attractively priced segments of the market that warrant investor attention.”
Borho disagrees that the biotech sector is expensive. In fact, it is cheap compared to its peers, he says.
“If you look at the S&P 500 and the top 50 names the two fastest growing are Amazon and [biotech company] Gilead,” he said.
“Both will double revenues from 2014 to 2015 and the EPS [earnings-per-share] growth rate is very similar, so if you compare P/Es Amazon is on 80 and Gilead is on 9 times 2016 earnings and 14 times next year’s. So Gilead has a higher growth rate than Amazon but a fraction of the P/E.”
Borho notes that the stock has a similar rating to low-growth large-caps such as Exxon.
He says that when commentators warn of high valuations on the sector they are normally using figures that are distorted by outliers and are based on last year’s earnings rather than next year’s, thereby not accounting for the sales from drugs that are being launched that are essential to the investment case.
“Most of the time people talk about a bubble they are looking at last year’s earnings and looking at unprofitable companies to get the P/E.”
Borho says there are some pockets of over-valuation in biotech, in particular some IPOs have been priced too high and some early stage companies too.
“The large profitable forms like Gilead and Celgene and so forth are trading on low multiples of P/E relative to their growth rate,” he said.
“Investors are willing to pay an average forward 15 times for pharma but only 12 times for profitable biotech. But the growth rate in biotech is three times higher.”
“That’s tough to understand. We can only really explain it with sentiment shift.”
Borho says that the shift in style took many investors by surprise and they quickly shifted their money out, compounding the falls for the sector. This is backed up by ETF fund flow data which shows that lots of “hot” money left the sector during the correction.
The Biotech Growth Trust lost 80 per cent during the bubble of the early 2000s, but is only 21 per cent down in the recent correction.
Data from FE Analytics shows you would have actually outperformed the S&P 500 in the biotech sector despite the crash in the market thanks to the strong growth made prior to that.
Performance of trust since launch
Source: FE Analytics
As well as the rotation from growth into value, Borho points to political concerns in the biotech sector.
“There were a couple of issues which accelerated this: the Waxman letter to Gilead was one,” he said.
Left-leaning senator Henry Waxman wrote an open letter to Gilead Sciences questioning the pricing of its new drug Sovaldi, which is the first cure for Hepatitis C and is expected to cost US healthcare insurers billions.
Each pill of the drug, which has to be taken for only three months to cure the illness, costs $10,000, Borho says.
Waxman raised the concern that this could be too high and asked how the company would ensure poorer people would receive the drug.
“Now everybody is worried about Gilead’s pricing and the whole market has turned from fundamentals to sentiment,” Borho said.
He argues that the new drug will actually reduce healthcare costs overall as it will remove the need for highly expensive liver transplants and for lifelong treatments – it is the first ever cure for the malady.
However, the drug is expected to achieve huge sales in the first years as all patients of baby boomer age will be offered a liver check-up from this year and Borho says sales are likely to be ahead of expectations.
FE Analytics data shows 33 IMA funds have put Gilead in their top 10. It makes up 10.3 per cent of the Biotech Growth trust.
Borho says the biotech sector should receive a boost in the coming month as companies report their earnings, including Gilead.
“We will see the first quarter of sales of the Hep C cure which will certainly print high number above consensus estimates,” he said.
The conference of the American Society of Clinical Oncology in late May should also give a boost with good news expected about new treatments, he says.
Overall Borho says that the strong expectations for the sector which he had at the start of the year remain intact.
“There were strong expectations going into this year of strong earnings acceleration in the Biotech sector and good fundamental performance together with some really exciting news flow,” he said. “Prices have become detached from fundamentals.”
