After finishing 2018 as one of the worst-performing sectors, it looks like biotech could be a runaway leader this year.

The iShares Nasdaq Biotechnology ETF (Nasdaq: IBB) has surged 13% so far this year, nearly four-fold the return on the S&P 500, after having crashed 11.8% last year.

Valuation multiples are down and acquisition activity for 2019 is already 26% of last year’s total.

Biotech is one of the few industries that should remain relatively immune from worries over the trade war and could be a bright spot in an otherwise volatile year.

In perhaps no other industry is stock-picking more important than in biotech.

Investor sentiment could boost the entire group, but it will be the individual companies with breakthrough drugs that will provide outsized returns.

Get Ready For The 2019 Biotech Boom

The market was largely disappointed in biotech acquisitions last year and investors reflected their dissatisfaction in share prices. Passage of the tax cuts was supposed to mean excess cash and repatriated earnings by mega-cap pharmaceutical names.

The theme was that another patent cliff would spur a wave of buying in small- and mid-cap biotech names to shore up the weakening pipelines for larger players. More than $26 billion in annual sales was put in jeopardy by patent expirations in 2017 alone, and the industry is facing record patent losses if it cannot fill the gap with new drugs.

But biotech valuations remained high through most of the year, and the largest pharmaceutical buyers spent their excess cash on buybacks instead. Threat of price controls increased uncertainty in the industry and executives decided on a wait-and-see approach instead.

However, the late-year selloff changed the dynamic, and it looks like we could see the M&A boom explode in 2019.

Bristol-Myer’s Squibb (NYSE: BMY) started the year by announcing one of the largest pharmaceutical acquisitions ever, an agreement with Celgene (Nasdaq: CELG) for $74 billion in cash and stock. Celgene’s pipeline is one of the best in its space, and the combined company would have nine blockbuster drugs with sales over a billion annually.

The announcement was followed closely by the decision by Eli Lilly (NYSE: LLY) to pay $8 billion for Loxo Oncology (Nasdaq: LOXO), its largest acquisition ever and a 68% premium on Loxo’s prior closing price.

Chicago-based law firm Baker McKenzie and Oxford Economics estimate 2019 health care M&A could increase to $413 billion including the Celgene and Loxo deals, a 33% increase on 2018 volume. While industry valuations are still trading around 20 times trailing earnings, price multiples have come down 20% since September, which is bringing out the buyers.

Another tailwind is that it appears administration efforts to speed up drug approvals are starting to work. Research by the website Pharma Exec found it took, on average, 300 days for a drug using Fast Track status to be approved by the Food & Drug Administration (FDA) in 2015. That number dropped to an average of just 250 days in 2017, and the average days for approval in other expedited categories have also decreased.

Individual acquisitions will depend on the pipeline needs of the acquirer, but investors should look to smaller players with early-stage approvals in valuable segments like rare diseases, oncology, and immunology.

3 Biotech Stocks That Scream, “Buy Me!”

Companies with drugs treating rare diseases, oncology, and immunology could see especially high interest. Rare disease treatments bring longer patent protection and usually higher list prices while oncology and immunology treatments are some of the most expensive in the industry.

BioMarin Pharmaceutical (Nasdaq: BMRN) is a leader in genetic-disease therapeutics and has seven commercially-approved drugs in the pipeline. The company has two treatments, vosoritide for dwarfism and valoctocogene for hemophilia A, expected to launch in 2020 and could each become blockbusters with sales over $1 billion.

The $16.8 billion company has proven its skill at manufacturing enzymes for rare genetic diseases and is a sought-after partner in drug development. Earnings are expected to turn positive in the third quarter on full-year revenue growth of 14% to $1.73 billion.

Incyte Corporation (Nasdaq: INCY) has the only products approved for rare blood cancers polycythemia vera (PV) and myelofibrosis (MF). The company’s headline drug, Jakafi, which is used for treatment of MF, produces sales of $1.4 billion in the United States alone. Efforts to expand the drug’s use in other diseases could push sales over $2 billion.

Jakafi enjoys patent protection to 2026 and the company is expanding its pipeline in oncology and autoimmune indications. Earnings are expected higher by 90% this year to $2.11 per share on a 19% increase in revenue to $2 billion.

Clovis Oncology (Nasdaq: CLVS) has been under pressure from activist Armistice Capital to sell itself after GlaxoSmithKline offered $5.1 billion for a similar biotech, Tesaro Inc, in December. The $1.3 billion biotech has three drugs approved for cancer treatments and generating over $95 million in annual sales.

Clovis received approval for its ovarian cancer treatment in Europe last quarter and plans on filing a new drug application (NDA) for prostate cancer later this year. Sales are expected to jump 47% to $140 million in 2019 and the company has an extremely strong balance sheet with $604 million in cash.

Risks To Consider: A potential acquisition shouldn’t be your only rationale in a long position. Make sure you position in companies with strong fundamentals and upside even if a buyout doesn’t come.

Action To Take: Position in small- and mid-cap biotech names with strong pipelines on the potential for a 2019 boom in pharmaceutical acquisitions.

— Joseph Hogue

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Source: Street Authority