Many investors have steered clear of biotechnology investment trusts fearful of a US government intervention on high drug prices. However, Stifel analyst Anthony Stern believes these concerns are overblown.
With this in mind, he has highlighted two biotech trusts offering attractive buying opportunities, given their shares trade around 8% below their net asset values.
Stern points out that US politicians take issue with 'price gouging' for older, off-patent drugs rather than the new innovative drugs that biotech stocks work on.
‘As evidenced by President Trump’s failed initial attempt to restructure Obamacare, the US healthcare system is complicated and difficult to reform. Any changes are unlikely to be as significant as the market fears, will be slow in coming and are likely to have less of an impact on innovative biotech treatments,’ Stern noted.
The analyst believes the longer-term outlook for biotech companies remains positive, supported by ageing demographics and a growing middle class in emerging markets.
However, the perceived cloud hanging over the sector has depressed biotech share prices with the six biggest 'mega caps' trading on 13 times forecast earnings (P/E) for this year, below the multiple of 17 that more mainstream US pharmaceuticals stand at.
That said, the P/E rating of biotechs rises to 18 when Gilead Sciences (GILD.O) is included.
‘It is rare for a sector with higher forecast growth rates to trade at a discount to the wider US market,’ Stern pointed out.
Stifel’s top pick in the sector is International Biotechnology Trust (IBT) on account of the manager Carl Harald Janson’s strong track record and focus on small and mid cap stocks. This offers investors greater portfolio diversification, says Stern. For example, IBT has 51% of the portfolio in its top 10, while Biotech Growth Trust (BIOG) has 70%.
IBT currently trades at an 8% discount to net asset value (NAV) which is slightly narrower than its one-year average of 10.7% and half the level at the height of the uncertainty from the US presidential election last September.
The trust has shrugged off a rough three months – in which its share price fell 4% – to return 41.3% in the past year, ahead of the 26.5% 12-month gain in the Nasdaq Biotechnology index. Over five years shareholders have enjoyed an impressive total return of 221.5%, beating the benchmark's gain of 196%, although growth in the underlying portfolio was slightly lower than this at 1992%.
‘Since the trust has introduced a dividend (4% of NAV, paid out of capital), the discount has narrowed sharply from 15% to around 9%, and this yield may provide discount support in the current low yield environment,’ Stern said in a recent note to investors.
Stifel also has positive outlook for Biotech Growth. Although it has lagged the Nasdaq Biotechnology index and IBT over one, three and five years, the analyst expects its focus on large and 'mega cap' stocks will pay off. This is because Stern believes valuations also look attractive in this space.
BIOG currently trades on an 8% discount to NAV, slightly wider than its 12-month average of 6% and well below the 1% premium the shares stood at in December. Over one year its share price is up 18% and 181.4% over five years.
‘Unlike the other two biotech funds we cover, we believe there is little discount risk on the trust as the board seeks to protect a 6% discount level and the fund currently trades below this level at a 9% discount,’ Stern noted.
Stifel’s optimism does not extend to Swiss-listed BB Biotech (BION), however. Although its NAV performance has been strong over five years, with a 268% return, the analyst has concerns about discount risk. BB Biotech currently trades at a 5% discount.
‘We remain cautious about the discount risk as should sentiment to markets change we could see this widen out. We retain our “neutral” rating,’ Stern added.