Biotech Is Due for a Comeback. 5 Stocks That Could Lead a Revival.

“By mid-August, family and friends were stealthily moving fragile objects out of the reach of biotech investors,” said a recent note from a biotechnology analyst at Cowen.

That widespread pain across small-cap and mid-cap biotech, and beyond, may come as a surprise at a moment when shares of Moderna (MRNA) and BioNTech (BNTX), the two companies that developed the most effective Covid-19 vaccines on the market, have climbed 273.3% and 307.9% so far this year, respectively.

Their skyrocketing share prices, however, are the exception in the sector. The SPDR S&P Biotech exchange-traded fund (XBI) is down 4%, during a period when the S&P 500 index has climbed 20.4%. Another ETF that tracks biotech, the iShares Biotechnology (IBB), is up on the year, but is capitalization-weighted, meaning that much of its assets are dedicated to larger names. Moderna and BioNTech alone make up 13.5% of its portfolio, and Jefferies analyst Steven DeSanctis calculated in a recent note that Moderna contributed 8.4% of its return.

There have been renewed signs in recent weeks, however, of substantial value hiding among the biotech dross.

In late August, Pfizer (PFE) paid a 203.8% premium over the previous day’s closing price for Trillium Therapeutics (TRIL), a biotech with two promising cancer drugs. And earlier last month, Sanofi (SNY) paid a 30% premium for Translate Bio (TBIO), a messenger RNA pioneer.

In an effort to find more-attractive bets in biotech, we talked to investors and analysts who focus on the field. They offered a list of interesting names, including Compass Pathways (CMPS), the United Kingdom–based biotech company testing the chemical in psilocybin mushrooms as a depression treatment, and Acceleron Pharma (XLRN), which is working on a drug for a rare cardiovascular condition.

Other picks include year-to-date losers AlloVir (ALVR), down 48.3% this year; the genetic testing firm Invitae (NVTA), down 27.3%; and the aforementioned Sarepta, down 53.5%.

Close watchers of the biotech market have different explanations as to why the sector has been so weak since early February. The underperformance comes after a notably strong 2020, and the major ETFs that track the sector still slightly outpace the S&P 500 over a two-year window.

“It basically overshot during 2020,” says Ziad Bakri, manager of the T. Rowe Price Health Sciences fund (PRHSX). “The sector got a little too hot, and probably got a little bit ahead of itself, toward the end of last year.”

Investors and analysts widely agree that the slump since February has something to do with confounding signals coming out of the U.S. Food and Drug Administration, an agency that has enormous sway over the fate of the sector and one that has been without a permanent leader since President Joe Biden assumed office.

“We’ve seen a lot of uncertainty with the FDA,” says Neena Bitritto-Garg, an analyst at Citigroup. “That’s kind of bleeding into sentiment in the sector.”

In March, analysts started ringing alarm bells about a series of unexpected FDA actions after surprise moves by the agency led to sharp drops in share prices of Acadia and FibroGen (FGEN). The agency’s decision to approve Biogen’s (BIIB) Alzheimer’s disease therapy in June, despite limited evidence for its efficacy, drew widespread criticism and raised even more questions about the agency’s direction.

Investors have also worried about a Federal Trade Commission warning earlier this year that it intended to take a more aggressive approach toward regulating pharmaceutical mergers, not to mention the resurfacing of the perennial drug-pricing debate.

Another drag on the sector has been the slow pace of biotech mergers and acquisitions after a busy 2020.

The investment case for small- and mid-cap biotech stocks often relies on those companies eventually being acquired, notes Alethia Young, an analyst at Cantor Fitzgerald. “I think people had lost hope,” she says.

Another factor, cited by Ritu Baral, an analyst at Cowen, may be that the fire hose of initial public offerings in biotech has stretched investors’ capital very thin. “We think it has eaten into the liquidity in the greater biotech market,” Baral says.

Biotech stocks showed signs of life in late August, and the SPDR S&P Biotech rose 13.8% from Aug. 19 to Sept. 1.

As deal making by pharmaceutical companies seems to be reviving and worries over the FDA ease, investors could place a broad bet on the recovery of small- and mid-cap biotech names by buying the SPDR S&P Biotech.

For investors with more ambition and patience, the broad weakness in biotechnology creates opportunities to find the next breakout star at a bargain price.

Here are five stocks highlighted by the experts we consulted, ranked by market value:

Acceleron Pharma

Acceleron is up 1.4% on the year, and T. Rowe’s Bakri says it has lots of room to grow.

The company is developing a drug called Sotatercept to treat pulmonary arterial hypertension, a rare cardiovascular condition that can become fatal over time.

“This is a market with a ton of value in it,” Bakri says.

In 2017, Johnson & Johnson (JNJ) spent $30 billion to buy a company that focused on the disease. Acceleron’s Sotatercept is in Phase 3 trials, and Bakri says that the Phase 2 results were very positive. “The data look outstanding in Phase 2,” he says. “The doctors are excited about it; it’s a well-characterized market, meaning there’s very little commercial risk if this works in Phase 3.”

While clinical risk remains, Bakri thinks it’s relatively low. “There are multiple lines of evidence that this seems to work,” he says.

Invitae

Shares of the genetic testing firm Invitae are down 27.3% this year, but that hasn’t dampened Eli Casdin’s enthusiasm for the stock.

Casdin, founder and chief investment officer of Casdin Capital, has recommended the stock to Barron’s before, including at our Biotech Roundtable in September 2019. The stock is up 61.2% since then, but has fallen sharply since February along with the rest of the sector. He says that the company’s fundamental business remains strong.

“That’s the thing that gives investors confidence,” Casdin says. “Markets correct on a macro. Business is still ripping on a micro, and penetration rates are incredibly low. Oh, this thing has a long way to go.”

Invitae generated $116.3 million in revenue in the second quarter of 2021, up 152% from the same quarter the previous year. The company offers a range of genetic tests, including prenatal screenings and tests that can help target cancer treatments.

Casdin says that volumes and revenues have tripled over the past three years, and he expects them to triple again over the next three years.

“I think it’s a great long-term opportunity,” he says.

Sarepta Therapeutics

Shares of Sarepta dropped 51.3% on a single day in early January, when the company shocked investors with disappointing data on a small trial of its gene therapy for a serious disorder known as Duchenne muscular dystrophy. The stock has not recovered.

Janus Henderson stockpicker Andy Acker, who leads Janus’ Health Care Sector Research Team and manages the Janus Henderson Global Life Sciences fund (JAGLX), thinks that Sarepta’s next trial of the same gene therapy could turn out better.

“There are a number of reasons why we think that study failed, and why the next study still has a good chance of success,” he says.

Data from the new trial won’t be available until late 2022 or early 2023, so a bet on an improved result will take some time to play out.

Still, Acker says that many had expected shares to climb over $200 if the data had been positive in January, and that they could still get that high. The stock is trading below $80 per share.

Compass Pathways

A pharmaceutical based on the compound that gives magic mushrooms their kick sounds like a dorm-room fantasy, but it’s no hallucination.

Compass is running a Phase 2b trial of a psilocybin therapy in patients suffering from treatment-resistant depression that is expected to report data by the end of the year. Investors have soured on Compass, and its American depositary receipt are down 30.2% this year.

“People are kind of discounting it right now,” says Citi’s Bitritto-Garg. “There’s some skepticism around whether or not psychedelics can actually be FDA-approved drugs.”

Yet as Bitritto-Garg notes, the FDA has already approved one medicine derived from cannabis. Cowen’s Baral, who also likes Compass, says that “there’s significant potential upside for that stock” when it reports its Phase 2b data later this year.

AlloVir

Shares of AlloVir are down 48.3% this year, and Piper Sandler analyst Christopher Raymond says there’s no good reason for it.

The company is developing what’s called a multivirus specific T-cell therapy, intended to treat or prevent viral infections in people who have received stem cell transplants.

“I think they have been, more than anything, victim of the broader sentiment that mid-cap names have fallen out of favor,” Raymond says.

The company already has proof-of-concept data showing that the therapy, known as Viralym-M, can treat those infections. It is awaiting data by the end of the year on prevention of those infections, according to Raymond.

He says that the stock could jump if that data turn out to be positive, as it would substantially expand the opportunity for the drug. Raymond expects AlloVir to have revenue of $1.3 billion by 2028. He has a $55 price target on the stock, implying a more-than 175% share price increase over its recent price of $19.89.

Write to Josh Nathan-Kazis at [email protected]