Biotechs and Stimulus

It looks like the industry that loves to give injections is now getting an injection of its own. And it isn’t complaining one bit.

U.S. Federal Reserve stimulus injections have helped biotechnology companies in America gain popularity once again after years of being ignored by the average investor. Since stimulus first began in early 2009, the S&P Biotechnology Select Industry Index (SPSIBI) has climbed over 150%, while the Nasdaq Biotechnology Index (NASDAQ: NBI) has jumped 212%.

Inspired by the U.S. Federal Reserve, Japan’s own debt purchasing program worth USD $68 billion each month has lifted the Japanese stock market some 80% in the last 6 months, with the country’s health sector benefiting enormously as 5 of the 10 best performing companies listed on JASDAQ are in the biotech space.

Japan’s Focus on Health Care

The Japanese government has good reason for giving its health care industry a good shot in the arm. Japan has one of the largest seniors base in the world, with 24.8% of the population aged 65 or older compared to the U.S.’s 13.9% in that age group.

Japan also has two population bulges, the first already in the senior bracket, aged 60-74 (born 1939-1953), and the second to be reaching the senior bracket in just two decades, now aged 35-44 (born 1969-1978). (All data: CIA World Factbook.)

It makes for good economic planning to support biotech and other health care companies to ensure a sufficient supply of health care services now and in the future.

Japanese Prime Minister Abe has promised to reform the nation’s Pharmaceutical Affairs Law, governing research and development in biotechnology. He also announced intentions for a government-funded medical research center with new regulations for stem cell research aimed at speeding the development of regenerative medicines and treatments. To stimulate the field, stem cell research is receiving a hefty dose of funding injections to the tune of 110 billion yen ($1.07 billion) over the next 10 years.

Kazuyuki Terao, chief investment officer at Allianz Global Investors Japan, explained to Bloomberg the reason for surging stock prices in the biotech sector:

“The market expects quantitative and qualitative easing to continue long term, boosting liquidity and drawing investors to speculative shares like biotech…Japanese Prime Minister] Abe raised health-care reform as a part of his growth plan and that’s also supporting the buy.”

Subsidies in Lieu of Revenue

The massive stimulus programs in both the U.S. and Japan have to a large extent been fuelling the rise of biotech stocks in both countries – perhaps to a much larger extent than investors ought to be comfortable with.

Many Japanese biotech companies have yet to generate profits, but they are surging in price nonetheless. Euglena (TYO: 2931) has skyrocketed 10-fold in the last 5 months (1,000%) and currently trades at about 335 times forecast earnings. D. Western Therapeutics has risen over 1,000% in the last 4 months, even while projecting a 203 million yen loss this fiscal year and not reporting a profit since 2006. Japan Tissue Engineering has risen some 750% in the last 4 months despite reporting annual losses for 8 straight years since 2005.

Similar examples of soaring health sector stocks in the absence of net profit dot the American biotech skyline. One case in point is Sangamo Biosciences (NASDAQ: SGMO), whose stock has returned 258% since the start of 2012, even though the company lost $22.3 million last year and received its $21.7 million in revenue from research grants and partnership agreements. It has yet to bring a single drug to market in all of its 18 years of operations.

Another is Isis Pharmaceuticals (NASDAQ: ISIS), whose stock has risen over 150% in the last 6 months even while the company reported pre-tax losses every year since its 1991 listing.

Terao, quoted above, notes that investments in many of the Japanese biotech companies are purely to benefit from continued BOJ stimulus and are highly speculative given the lack of profit generation. Outspoken U.S. Federal Reserve critic Jim Grant of “Grant’s Interest Rate Observer” similarly attributes “grievous distortions of asset values” in the biotech space to stimulus.

But should investors pile into a space simply because the land’s central bank has promised to throw more money at it?

Buying Into Potential

Others are not daunted by any stimulus-fuelled valuation surges in the biotech space. Investors seem happy enough buying into tomorrow’s potential without requiring very much balance-sheet convincing today.

They believe that research and development has become much more efficient with the tremendous advances in technology over the past two decades since the last pharma-stock surge of the 1990’s. As well, governments have over the years taken great strides in providing federally-sponsored research centers, offering aid to even the smallest medical research companies.

As long as stimulus is directed toward lasting improvements in R&D facilities and technology – as Japan recently announced part of its stimulus would be – investors will be willing to pay even a premium for a stake in the wonder drugs and miracle treatments of the future.

And both nations have the aging populations to back this up. In the U.S., baby boomers are entering retirement and requiring more health care than ever before. And Japan is seeing a similar trend.

“It is still a good time to invest in some Japanese biotech ventures to hold long term,” Ikeno expressed his optimism. “The stocks will be volatile in the short term, but still have great potential for gains.”

The stimulus lifeline tossed to the biotech industry today could in just a few years’ time produce the results it was designed for: supporting fledgling biotech companies through their growing pains as they mature into flourishing businesses, providing aging populations with the medicines and treatments they will be needing.

Viewed from that longer-term perspective, an investor might find Euglena’s future potential worth the high trading valuation noted above. A venture formed by the University of Tokyo, Euglena is conducting research into using single-cell algae to make an alternative to carbon-based jet fuel, and it expects to produce a steady supply by 2018. The company’s technology was referenced in Japanese government discussions on the benefits of stimulus into the biotech and energy sectors.

Japan Tissue Engineering Co., also noted above, recently won insurance coverage approval from Japan’s Health Ministry for two of its cartilage and skin treatments, opening the door to a wider market for the company.

For investors not comfortable with the high failure rate or lengthy product development programs of individual biotech companies, sector ETFs may be a more secure way to go, including:

• iShares Nasdaq Biotechnology (NASDAQ: IBB) allows investors to trade the NASDAQ Biotechnology Index containing 128 NASDAQ-listed biotechnology and pharmaceutical companies.
• SPDR S&P Biotech (NYSEArca: XBI) allows investors to trade the S&P Biotechnology Select Industry Index containing 51 American biotech and pharma companies.

Joseph Cafariello

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