Julius Baer: Biotech - an attractive environment?

Recent acquisitions by large cap pharmaceutical companies, at substantial premiums, bode well for the industry. Given their problems with filling their product pipelines with new drug treatments, and patent expiries on major products, we expect more beneficial deals to take place in 2009.

The industry’s fundamentals remain positive and we expect the majority of large cap companies will continue to show above average earnings growth and predictability. For example, Gilead Sciences announced fourth-quarter 2008 earnings which where up 45 per cent year-on-year, largely driven by sales of HIV drugs Truvada and Atripla. We estimate earnings per share (EPS) growth for 2009 will be 17 per cent.

We also believe a number of small and mid-cap stocks in the sector are fundamentally sound and trading at attractive levels.

We anticipate the launch of more than 40 new products this year. Each of these products should have sales potential of at least $200m. Around 70 per cent of these products come from biotechnology companies and will be sold on their own or in co-operation with pharmaceutical companies.

President Obama has announced a sweeping healthcare reform in the US. The success will rest on the ability to slow spending growth while creating affordable healthcare for every US citizen, including the 45m uninsured. With the US in recession, healthcare reform could take a back seat to the economy. The greatest hurdle will be cost, which is estimated to increase spending by around $65bn a year.

The solutions will take time to implement, therefore clinical trial success or failure will remain vital for biotech stock prices. The enthusiasm for science and innovation from the new US administration should lead to a less politicised Food & Drug Administration (FDA), making it easier for products to gain approval - a major positive for the biotech industry.

There are some areas of concern, so stock selection remains crucial. In the current market it is important for companies to manage capital spending efficiently and hold enough cash to get through the next clinical milestone. Investors who focus on defensive factors such as earnings predictability, liquidity and value should have the potential to make a profit.

Eric Bernhardt and Nathalie Flury are fund managers at Julius Baer Biotech Fund. The views expressed here are their own.