How to Invest in Pharma/Biotech in late-cycle bull markets

Want to invest in Pharma/Biotech companies? Here’s our quick guide on how to Invest in Pharma/Biotech in late-cycle bull markets

Health, some say, is a human’s greatest asset. That’s why restoring an ill body back to a healthy state is such a big business. Just recently, Novartis, a Swiss pharmaceutical giant, established a world record for a drug called Zolgensma. It treats spinal muscular atrophy. The cost? An eye-watering US$2.1 million.

Dwindling Number of UK Pharma Giants Limits Choices

In the UK, pharmaceuticals and biotech are one of the country’s strongest sector. Thousands of highly-skilled scientists worked tirelessly in the sector. So vibrant is the industry that Japan’s Takeda paid a staggering £46bn to own UK’s Shire Pharmaceuticals, a deal completed only in January this year. Shire’s exit left only two pharma behemoths standing in the London Stock Exchange: GlaxoSmithkline (GSK) and AstraZeneca (AZN).

Of the two, AstraZeneca is valued more highly. Not only is Astra’s dividend yield lower than Glaxo’s, its price-earnings ratio is more than double to that of its long-time rival, 41.8 against 20.1.* Moreover, Glaxo’s current share price of 1,580p is no higher than it was back in 1997. So bleak is Glaxo’s valuation that Investor Chronicle suggested in January ’18 that “Times’s up for Glaxo.”

Still, investors buy Glaxo for its yield (5%), or Astra for its modest growth. For strong growth, you will have to cast your search elsewhere in the sector.

Where’s Growth in UK Biotech/Pharma Sectors? 

Growth, it appears, has to be found outside the big guys. Among smaller UK stocks, in the sub-£5bn space, there are Hikma (HIK, middle-east pharma), Dechra (DPH, vet drugs) and Genus (GNS, livestock genetics).

Performance-wise, all three saw a big run-up in their share prices in the current bull cycle. For example, Dechra’s shareholders reaped a 350% gain in the five years to 2018 before a sharp correction followed.

The questions now are: Should one chase the pharma sector higher? What’s the risk?

First, you should bear in mind that the sector has had a few good years this decade. The risk of a sector correction increases as the bull market rolls on. Look at DPH’s correction last year – sudden, sharp, and large. Indivior (INDV), a spun-off from Reckitt which treats opioid addiction, saw its share price collapse from 480p to 44p in a year. So stop loss is important.

Second, concentrate on buying only after a general market consolidation. That’s when you can pick up stocks at a cheaper valuation.

Third, distinguish between the riskier biotech firms and the more established pharma. The former can be lucrative – but are riskier too. Perhaps mixing some ‘safer’ bets with riskier one is called for at this market cycle.

Fourth, you may wish to pursue pharma stocks on a thematic basis. Growth in some niche sector is still going strong, such as cannabis-related medicinal stocks. GW Pharma (Nasdaq: GWPH), a US-listed UK pharma that treats multiple sclerosis with cannabis-derivative drugs nabiximols, saw tremendous growth in its share price this year, up nearly 80% (see below).

Fifth, you may use technical rules to filter/search for trending biotech stocks. New price highs is one of these conditions. Look at Nuformix (NFX)’s chart. Buying at new highs is a profitable strategy here!

Diversification is important in Pharma/Biotech investing

If you are unable to follow the sector closely, individual stock picking is probably best avoided. Instead, diversify. To achieve this, you either buy into an investment fund/trust, or an exchanged-traded fund (ETF).

Curiously, sector ETFs like healthcare are not yet established in the UK. There are no sterling-denominated healthcare ETFs. There are a few listed ETFs in the LSE, although these are quoted in US dollars because they invest primarily outside the UK.

Among the healthcare investment trusts, the better known ones are Worldwide Healthcare Trust (WWH), Biotech Growth Trust (BIOG), BB Healthcare Trust (BBH) and Syncona (SYNC). WWH is, as its name depicts, a large fund that invests globally, include US, Europe and Japan. This gives investors a good geographical spread of life-sciences stocks. Its share price is remarkably bullish (see below).

In the US, the iShares Biotech ETF (IBB) is a viable alternative.

As a final note, the challenge of investing in pharma/biotech during a late-stage bull is very tricky. Simply because of the run-up in prices, sentiment, and valuation. Any clinical failure will cause a big dent in share prices. However, if you follow the above guide you may still be able to bag some winners.

A Summary of Listed Healthcare Stocks and Investment Trusts

  1. AstraZeneca (AZN) 3.6% – £79.8b
  2. GlaxoSmithKline (GSK) 5.1% – £78.9b
  3. Hikma Pharmaceuticals (HIK)  1.5% – £4.2b
  4. Dechra Pharmaceuticals (DPH) 0.9% – £2.8b
  5. Genus (GNS) 1% – £1.76b
  6. Worldwide Healthcare Trust (WWH)
  7. Syncona (SYNC)
  8. Biotech Growth Trust (BIOG)

* Sunday Times, 26 May 2019

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