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Biotech stocks have struggled in recent quarters as high interest rates take a toll on the capital-intensive sector. Jared Ablass, Vice President, Portfolio Research at TD Asset Management, speaks with MoneyTalk’s Greg Bonnell about how the sector could benefit once rates start to come down.
Transcript
Greg Bonnell – Well, equity markets keep reaching new all-time highs. It’s been a rough two-year stretch for the biotech sector. There are some signs, though, that better days may be ahead. Joining us now to discuss, Jared Ablass, VP Portfolio Research at TD Asset Management. Welcome to the program. It’s great to have you here.
Jared Ablass – Thanks for having me, Greg. Good to be here.
Greg Bonnell – All right, so let’s dig in. We don’t talk about biotech a lot on the show. As we were saying, it’s been a bit of a rough stretch. What’s been driving that underperformance?
Jared Ablass – Yeah, so definitely a rough stretch. I actually brought a chart here to demonstrate what we’re seeing. If you look, up until 2022, it had been a pretty strong performer. It’s the black line here. What you’re seeing is the XBI Biotech Index. That’s an equal-weight composite. About 120 companies in the US, all the biotechs north of $500 million market cap. And a very sharp draw-down. Maybe a bit small to see, but in that red there, what you have is a 60% drawdown over 2 years, which is actually the largest for this index as far back as we have data, which goes back pre-2008, 2009.
So sharp drawdown. What you have in the green line is the US 10-year interest rate inverse on the left axis there. You see a pretty sharp correlation. So as far as whether rates decreasing could help, absolutely it looks like that. But I’ll give you a little context as far as what drove that sharp downturn.
Really, the same driver, but you can parse it three different ways. I’d say first, you had a flight to quality. The stocks outperformed during this period are your large caps, like UnitedHealth (UNH), Johnson & Johnson (JNJ), Merck (MRK). This is a small-cap tilt, being the equal weight for the XBI. So that definitely took a toll.
Secondly, I’d say you had a duration impact. A lot of these are research companies. They maybe spin out of a university. Pre-revenue, actually, in a lot of cases. Not even just not earning money but, pre-revenue. So when you’re discounting a drug that’s not going to make it to the market for five-plus years, you really take a toll when you put the higher interest rate in the denominator of a valuation calculation.
And then third piece, I’d really say, is you’ve got a funding impact, where these companies are negative free cash flow. They need to tap equity markets, whether it’s an IPO, or a follow-on, to keep themselves going. And that really dried up the last couple of years.
Greg Bonnell – Can I charge you to show that correlation? I was thinking, what is that green line? OK, that’s the inverse 10-year bond yield. We are in a position now where the market is awaiting rate cuts. Is that one of the things that could help turn the sector around?
Jared Ablass – Yeah, absolutely. So I’d say fingers crossed. These are choppy data points, but funding so far has looked really good in 2024. In January, it was actually up over 200% year-over-year. That’s IPOs plus follow-on funding. We rolled to February. And the number held. It was up 200% again. Actually, up another 20% sequentially from January. So if those numbers hold, we’d be on track in Q1 for levels back to 2021 peak as far as fundraising ability. So certainly, the decrease in rates has investors more willing to lend their money to these type of companies.
And you can actually, if you want to gauge sentiment and what we’re seeing, look at market response to when companies raise money. And one I point out is Denali Therapeutics (DNLI). Sub-$5-billion company, burning money, burning cash, but doing a lot of interesting research in the neurological space. They announced a $500 million PIPE – Private Investment Public Equity. And the stock was up 40% on the day. So clearly, you have appetite for companies to raise cash.
And the other aspect that we actually haven’t talked about is M&A. It does factor in when these companies are looking for an exit to raise money. Oftentimes, they’re selling themselves to large-cap pharma. And we have had some activity on that side the last back half of 2023, really picking up with a couple of big deals that I’d highlight.
You had Amgen (AMGN), closed their acquisition of Horizon, almost $30 billion deal for a rare disease manufacturer. And then the big one was Pfizer (PFE) obviously trying to get over the downturn of COVID. And now, they’re trying to find a new revenue stream to backfill that COVID vaccine. Spent $40 million on Seagen for targeted oncology therapeutics.
Greg Bonnell – When we talk about perhaps a smaller company that wasn’t publicly listed that could have went the way of an IPO, but it gets swallowed up through M&A activity, does that distort the IPO picture, the health of it for this sector? Because there’s different ways of getting out there, isn’t there?
Jared Ablass – Yeah. And not only are they the acquisitions. There’s a lot of licensing activity that happens. A really hot space has been the GLP1s. And we’ve had a lot of activity there for weight loss. An example would be Astrazeneca (AZN). They went to China to license a GLP1 candidate from Eccogene in China. So a lot of activity, whether it is, like you said, public markets or private. Companies have been able to access funding, but certainly upticking in the last six months.
Greg Bonnell – If we’re going to talk about these drugs, let’s talk– you mentioned on the weight loss ones. This has been an interesting space, right? If you’re trying to look where there’s been activity in the market, we had fresh news today, I believe, out of Novo Nordisk (NVO) because not only are they saying we have delivered a drug now that promotes weight loss, they keep testing new ones they’re saying, at least at first glance, are more effective.
Jared Ablass – Yeah. So super interesting day for Novo today. They had their capital markets day in Denmark. They showed data for their oral next-generation asset that showed 13% weight loss at 12 weeks. And that’s in line with best-in-class injectables.
So if you can do that in an oral format, it’s very attractive. There are questions to be seen, just how it’s going to work out. You need a lot of the drug content in your system, being every day rather than once weekly oral. So manufacturing will be a question, but certainly, an attractive proposition. I did actually bring a chart there, as well, on the obesity companies. It’s really Novo Nordisk and Eli Lilly (LLY) leading the charge. You see in the top chart there, that’s total return for these two companies.
There are really five or six baggers over the last five years. There is multiple expansion. Eli Lilly is now just south of 60 times next 12 months earnings, which is a tech multiple, right? It’s a bit nerve-wracking for a pharma analyst. But the bottom plot is what I would draw your attention to, actually. That’s the consensus 2025 estimate for sales and how that’s evolved going back to 2019. And really, what you see is what brokers were thinking about four years ago. They’ve now had to revise, up their estimates for 2025 sales, by double in the case of Novo Nordisk, 70%-ish in the case of Eli Lilly.
So these are real launches that are very meaningful drugs. And like you said, now, they’re delivering follow-ons that can lose 20%-plus of body weight.
Greg Bonnell – That’s the kind of chart– when we show the audience, it’s the clearest definition is up and to the right. What’s the risk here, though? That someone else shows up and says, hey, we have a drug that’s even more effective than you, Eli Lilly or Novo Nordisk?
Jared Ablass – Yeah. So definitely, the risk is the other ones getting involved. You have Amgen with AMG133 is involved. Pfizer has tried a couple orals. Roche (OTCQX:RHHBY) acquired a business last year called Carmot Therapeutics. I think all told, there’s something like 40 companies working on this, over 100 candidates in the pipeline. And the other thing is just, it’s very early. We had multiple expansion on the proposition of losing weight, which is very attractive. 100 million people in the US are obese.
But now, we’re seeing things where it’s not only weight loss that matters, but it’s also, in August, you had Novo Nordisk show a 20% benefit to cardiovascular risk, stroke, heart attack, 20% reduction in that risk from taking a GLP1. We’ve seen positive data on MASH, which is a fatty liver disease. We’ve seen positive data on orthopedics and joint pain, positive data on osteoarthritis and sleep apnea as well.
So it’s just very broad-reaching. And you’re not sure whether the same mechanism will work as well in each indication. So it’s early. And we’ll see what the other companies come up with.
