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BofA/Merrill Lynch Sees New Era in Biotech Investing; Reinstates Coverage on 7 Large-Cap Names

October 1, 2014 7:34 AM EDT
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Analysts led by Ying Huang at BofA/Merrill Lynch see a new era in biotech investing and shoot-down ideas that the sector is in a "bubble." While the Nasdaq Biotechnology Index (NBI) outperformed the broader market with gains of 66% in 2013 and is on pace to do it again in 2014 (22% YTD, versus 7% for S&P 500), the firm said large-cap biotech offers favorable risk/reward with superior growth and a burgeoning pipeline.

Also, amid recent comments from Federal Reserve Chairwoman Janet Yellen that valuation for smaller firms in biotech are "stretched", the firm said while this may be the case for small-cap biotech they not believe valuation is overly stretched for the large cap stocks.

Huang notes that the average forward P/E for the six profitable large-cap biotech companies Alexion (NASDAQ: ALXN), Amgen (NASDAQ: AMGN), Biogen (NASDAQ: BIIB), Celgene (NASDAQ: CELG), Gilead (NASDAQ: GILD), and Regeneron (NASDAQ: REGN) is 20.7x, compared to 14.9x for the S&P 500. However, revenues of the seven large-cap biotech companies including Vertex (VRTX) grew from $32B in 2010 to $48B in 2013.

The firm sees multiple tailwinds to biotech at play. First, while many have criticized meager R&D productivity given increased spending, based on the number of FDA approvals of New Molecular Entities (NME) they observe an upswing in productivity and believe the industry has turned around. They also said the biotech industry is well positioned to benefit from the demographic trend in the developed world and higher utilization of care.

On the risks, the firm notes private payors and governments increasingly are speaking out against the burden of high drug prices. Also, relatively high valuation in the small and mid-cap (SMID) segment has become a hurdle for M&A.

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