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Equity Perspectives

Forty-three years after President Nixon launched a national war on cancer, Lord Abbett professionals analyze the battle against this dreaded disease. 

Make no mistake: treating cancer is one of the most significant human challenges we've ever faced…But now, for the first time, we are at an extraordinary moment in the history of cancer research because we finally are beginning to understand what causes cancer at a cellular, or molecular, or a genetic level in a way we just did not know ten years ago or even five years ago.
—Dr. Siddhartha Mukherjee, The Emperor of All Maladies: Biography of Cancer1

You can read a lot into the trajectory of the NYSE Arca Biotechnology Index (BTK) 2 over the last five years. (See Chart 1.) Behind the 295% gain (as of April 17, 2014) lies a wave of innovative weapons amid a rising global epidemic.3 It is a story of genomic breakthroughs, targeted molecules, and expansive immunotherapy that are expected to drive the global cancer drugs and treatments market to $143.7 billion by 2013, according to GMR Data. Some of the companies in the BTK were acquired at a substantial premium. Some sold the rights to their innovative technologies or partnered with large pharmaceutical companies. Others had the wherewithal to ride the long road of regulatory approvals and watch their company’s stock price rise to lofty multiples of sales and/or earnings.

With so much price appreciation, the market has questioned whether all the good news is already priced into biotech stocks, or whether the long-term fundamentals justify continued bullishness. While some biotech valuations have reached record highs lately, prompting some investors to trim their positions or sell out entirely, Deepak Khanna, Lord Abbett Partner, Portfolio Manager, cites three reasons to remain positive in the long run:

1) Young biotech companies with promising drug candidates in clinic have the ability to raise cash in the capital markets;

2) Research and development (R&D) has become much more adept at turning out commercial drugs, or at least drugs that prove effective in clinical trials.

3) The industry has only scratched the surface of targeting drugs to smaller patient populations based on vast amounts of genomic data.

Of course, Khanna has no illusions about the diseases for which there is still no cure—lung, breast, brain, and pancreatic cancer, for example. What drives his optimism, however, is the pace of technological progress that continues to accelerate.

"The players may change; the leaders may change; but now, the tools for drug discovery—mass spectrometers, liquid chromatography systems, nuclear magnetic resonance systems, and the like—are more precise than ever," he said. "And the combination of an aging population, improving detection and diagnostics, more research-savvy physicians, and more educated patients should be highly positive for this sector for the next five to seven years."

 

Chart 1.  After a Strong Five-Year Run, Biotech Stocks Have Taken a Breather
Cumulative returns in the NYSE Arca Biotechnology Index (BTK), April 20, 2009–April 17, 2014

Source: Bloomberg.
The NYSE Arca Biotechnology Index (BTK) is an equal dollar-weighted index designed to measure the performance of a cross-section of companies in the biotechnology industry that are primarily involved in the use of biological processes to develop products or provide services. Such processes include, but are not limited to, recombinant DNA technology, molecular biology, genetic engineering, monoclonal antibody-based technology, lipid/liposome technology, and genomics. The BTK Index was established with a benchmark value of 200.00 on October 18, 1991. The BTK Index is rebalanced quarterly based on closing prices on the third Friday in January, April, July, and October to ensure that each component stock continues to represent approximately equal weight in the index.
For illustrative purposes only and does not reflect the performance of any Lord Abbett mutual fund or any particular investment.  Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

Leveraging the Power of Genetic Information
In following the small cap therapeutics and services sector, Lord Abbett Research Analyst Matt DeCicco says companies focused on cancer or orphan genetic diseases have probably shown the biggest gains in recent years. That's because they are going after better targets with more effective drugs, thanks to an explosion of information about certain diseases since scientists sequenced the human genome in April 2003.

A case in point is a small California company that developed a drug for chronic lymphocytic leukemia (CLL), the second most common type of leukemia in adults, and which often occurs during or after middle age. Targeted to a certain protein that has been implicated in cancer cell growth, the drug was approved for CLL patients who are not getting first-line treatments like chemotherapy.

In December 2011, the stock was $15, and the company's CLL drug was in Phase 2 clinical trials. Since then, the company has partnered with a global healthcare giant to co-market and co-develop the drug, which helped drive its stock to around $150 a share.    

But that’s just one of a number of biotech companies that added considerable alpha4 to small cap portfolios. Other companies of interest are working on second-generation drugs designed to stop or slow the growth of blood cancers as well as solid tumors in lung cancer and breast cancer. 

"While the first-generation version of such drugs has already generated enormous revenues, tumors are formidable enemies: they can mutate and find other pathways to wage their own war on the body," said DeCicco. "So second-generation drugs in such cases seek to block not only the initial pathway a tumor took but also alternate pathways it might take to grow."

Now one might wonder what's driving the valuations of the biggest gainers in this sector. Like many emerging biotech companies, the answer is investor sentiment, otherwise known as multiple expansion, which is to say, a number of companies have yet to generate any earnings. Some are even "pre-revenue."

"Although some companies in this space are generating revenues from new drugs, what's driving a lot of emerging biotech stocks is better than expected clinical data," DeCicco explained. "In the case of the company with a promising treatment for CLL, the pivotal event was a phase-two trial that showed a significant improvement in progression-free survival in a sick patient population that few market observers anticipated."

Stock Picking Becomes More Important
In 15 years of covering the pharmaceuticals and biotechnology sectors, Lord Abbett Research Analyst Lavina Talukdar has seen a wide variety of up-and-comers morph into mid caps and large cap stocks with strong price appreciation, thanks to a growing presence in the cancer drug market. One notable example: a global leader in the HIV/AIDS business which has seen its market cap more than quadruple since it diversified into cancer therapies in November 2011. Now the question on many investors’ minds is whether stocks have gotten ahead of themselves in an otherwise slow-growth environment.

“Clearly biotech [and pharmaceutical] stocks have had a strong run, but as the companies continue to deliver significant revenues, earnings, and clinical trial results that surprise on the upside, investor interest should continue,” Talukdar said. “Will there be failures along the way? Sure, because this is a risky business. But I think both the quantity and quality of drugs are going to get better because companies are incorporating biology into the research and development process, which should lead to a massive increase in medicine that addresses the genetic and molecular causes of cancer.”

Some investors are even more excited about the prospects for immunotherapy, a treatment that uses certain parts of a person’s immune system to fight advanced cancers with relatively low five-year survival rates, even after radiation, surgery, and chemotherapy. This can be done by stimulating a patient’s own immune system to work harder or smarter to attack cancer cells, or by giving a patient immune system components, such as man-made proteins.

One leading company in this battle is currently investigating a number of different immune pathways and different treatment strategies in various tumor types. “Immuno-oncology is different because it uses the natural capability of the patient's own immune system to fight the cancer,” the company explains on its website. “We are developing novel immunotherapies that modulate the immune system. Our research is focused on transforming the way tumor cells and the immune system communicate, including checkpoint pathways.”

Meanwhile, other companies of interest are aggressively mining clinical trial data to develop new drugs that act on biological targets associated with cancer progression and/or treatment resistance. Among the most notable targets are metastatic brain, lung, liver, bladder, prostate, and ovarian cancers, as well as advanced leukemia and lymphomas, among others.

“Data from these trials will fuel understanding of individual cancer battles, but considering how far these stocks have advanced, there will probably be a lot more volatility this year than last year,” said Talukdar. “Stock picking will be more important than ever.”

Against that backdrop, Khanna and Talukdar both expect more mergers and acquisitions in the coming year as cash-rich companies scoop up smaller players with cutting-edge innovation.

“Advances in immunotherapy alone signal a paradigm shift in dealing with cancer,” said Talukdar. “I think this is the beginning of a five- to 10-year run in healthcare therapeutics.”

 

1 The Emperor of All Maladies is a “biography” of cancer that won the 2011 Pulitzer Prize for general non-fiction.  Written by physician, researcher, and award-winning science writer, Siddhartha Mukherjee, the book also is the basis of a forthcoming six-hour series on public television by documentary film maker Ken Burns.
2 The NYSE Arca Biotechnology Index (BTK) is an equal dollar-weighted index designed to measure the performance of a cross-section of companies in the biotechnology industry that are primarily involved in the use of biological processes to develop products or provide services. Such processes include, but are not limited to, recombinant DNA technology, molecular biology, genetic engineering, monoclonal antibody-based technology, lipid/liposome technology, and genomics. The BTK Index was established with a benchmark value of 200.00 on October 18, 1991. The BTK Index is rebalanced quarterly based on closing prices on the third Friday in January, April, July, and October to ensure that each component stock continues to represent approximately equal weight in the index.
3 According to the American Cancer Society, eight million people die each year from cancer, and an aging population is expected to drive that toll to 13.1 million deaths by 2030.
4Alpha is one of several popularly used terms that refers to risk-adjusted performance. It is is calculated by comparing the volatility of a fund or security to the risk-adjusted performance of a benchmark index. The alpha of the fund or security is the excess return compared to that of the index.  In other words, an alpha of +1.5 would mean that the fund or security had beat the benchmark index by 1.5%.

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The Fund seeks to deliver long-term growth of capital by investing primarily in stocks of mid-sized U.S. companies.
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The Fund seeks to deliver long-term growth of capital by investing primarily in stocks of U.S. companies.

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videoRead our blog, "Do Biotechs Have More Upside?" Join the conversation.

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