Markets

A Surprising Safe Haven

Biotech stocks thrive even as the market tanks. These four still hold plenty of promise.

From Kiplinger's Personal Finance magazine, December 2008

By Jennifer Schonberger

Sean Murphy, a 36-year-old marketer who lives in Washington, D.C., thought he was staring at a death sentence when he was diagnosed with lymphoma almost two years ago. Today, with the help of two Amgen drugs that boosted his immune system while he was undergoing chemotherapy, Murphy is cancer-free.

Although stories of miraculous cures have long been at the heart of the biotech sector's allure, great science hasn't always translated into great returns. But during the past year, it was biotech stocks that produced a small miracle. In 2008 through November 7, the Dow Jones U.S. Biotechnology Index gained 2%, while Standard & Poor's 500-stock index tumbled 37%.

Market dynamics, as much as laboratory innovations, explain the sector's relatively strong performance. For starters, biotechs can be safe havens in turbulent times. "Biotech companies have relatively stable earnings that are not dependent on broader economic factors," says Rajiv Kaul, manager of Fidelity Select Biotechnology fund. Just as important, the companies are as far removed from the turmoil of Wall Street as figure skating is from football.

A flurry of deal activity is also fueling interest in the group. In October, U.S. drug giant Eli Lilly offered $6.5 billion for ImClone. Last July, Switzerland's Roche bid $44 billion for the 44% of Genentech that it didn't already own.

Over the long term, it's all about new products. Investors look for biotech companies to invent cures for a wide variety of ailments, ranging from diabetes to various types of cancers. Biotechs are also expected to produce replacements for the large number of traditionally produced drugs that will lose patent protection over the next few years.

Investing in biotech can be risky. Many companies fail long before they ever bring a product to market. In looking for winners, focus on companies that are working on drugs with large market potential. The four firms below have strong pipelines of new products that could generate big future sales.

Huge winner. One of the industry's great success stories, Celgene develops drugs to treat various types of cancer. Analysts expected that sales, which were less than $4 million in 1998, would approach $2.2 billion for 2008 and that the company, which turned profitable in 2003, would earn about $705 million, or $1.55 per share, for the year. At $60, the stock (symbol CELG) is up 200-fold from its 1998 low (all prices are as of the November 7 close).

Celgene's best-known drug is Revlimid, which is used to combat multiple myeloma, a cancer of the blood-plasma cell. The drug is now being tested as a possible treatment for lymphocytic leukemia and non-Hodgkin lymphoma. Moreover, Celgene is making a strong push to sell Revlimid in new European markets (the company already sells the drug in nearly 75% of developed European markets) and has plans to launch in Canada and Australia as well. Sales of Revlimid surged 72% in the third quarter of 2008, to $342.6 million, and Value Line Investment Survey predicts that the figure could exceed $3 billion within three to five years.

Celgene's other big seller is Thalomid. (As thalidomide, the drug was associated with severe birth defects in the late 1950s.) Like Revlimid, it is a treatment for myeloma. Celgene also has big hopes for expanded sales of Vidaza -- which entered Celgene's portfolio with the company's $2.9-billion acquisition of Pharmion last March -- a drug to treat bone-marrow cancer.

The stock isn't cheap. It sells for 26 times the average analyst estimate for 2009 of $2.30 per share. But if Celgene can deliver the 38% annual earnings growth that analysts are projecting over the next few years, today's share price will look like a bargain.

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