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Two Biotech Stocks Set to Double on One Powerful Catalyst

Companies / BioTech Nov 21, 2014 - 02:46 PM GMT

By: Money_Morning

Companies

William Patalon writes: When I earned my MBA from the Rochester Institute of Technology (RIT) back in the mid-1990s, my focus was finance and investing.

But it was a management professor who clued me in to some of the best ways to "look past the numbers" and understand what really makes a big company tick.

The professor, Janet C. Barnard, retired a few years back and, sadly, passed away in 2012.


The talks that she and I had were invigorating "mini-lessons" – which is why we were still having them years after I tacked my graduate-degree diploma to my office wall.

I often "shared" those lessons with my readers – quoting the management professor in stories I wrote back during my days at The Baltimore Sun, as well as in columns I've written for you folks here at Money Map Press.

Now those lessons will pay off again as we look at these huge biotech opportunities…

I even put her insights to use as an editor and manager. Prof. Barnard was always fascinated by what I did for a living. And in one particular "epiphany" conversation, she observed that my writers were very similar to the research-and-development (R&D) folks who work in Silicon Valley.

The way she saw it, the "creative" focus of my writers was almost the same as the "innovative" focus of a tech researcher, meaning both groups required a similar mentoring, nurturing environment to achieve maximum success.

Indeed, a hefty percentage of the many talks Prof. Barnard and I had focused on innovation – the process that, when effectively harnessed, can create such a windfall for a company's shareholders. Innovation is the "seed corn" of future sales and profits. Once you understand that – and can learn to spot it, as Prof. Barnard showed me – you can cash in, in a big way, over and over again.

Innovation is a topic we write about fairly regularly for Private Briefing. And it's a topic we understand – as evidenced by the eight biotechs that have given Private Briefing readers gains of 100% or better (among the 33 stocks that have doubled or more since launching this service three years ago).

In short, innovation – I'll call it the "I-Code" – is one of the best future profit indicators you'll find.

And two innovation-related stories that broke yesterday – both huge, albeit under-the-radar reports – caused me to recall the lessons of my late, great MBA mentor yet again.

I'm going to share both those stories with you here today. And I'm going to show you two ways to profit.

So let's get started by looking at the first news story – a revelation that could force investors to "value" Big Pharma players in a very different way.

A (Very) Costly Development Cycle

I covered biotech for three years at The Sun. But I learned the most important sector lesson of all on my very first day on the beat: It can take 10 years and more than $1 billion to create a new drug. The failure rate is stunning. So a true "blockbuster" drug can make or break a company – even a big one.

Yesterday, in the first of the two news stories I want to bring your way, the Tufts Center for the Study of Drug Development – which came up with that original $1 billion new-drug estimate – updated its figures and boosted that cost projection to a staggering $2.9 billion.

According to Tufts researchers, the average out-of-pocket R&D cost on a drug has hit $1.4 billion. They added in another $1.16 billion for "time costs" – the profits investors forego while a drug is in development. Add in an additional $312 million for post-approval research, and you're talking about $2.9 billion.

Some folks have argued this figure is bloated (they estimate the cost at $186 million, which is probably too far the other way). But when you consider that Tufts' original estimate back in 2003 was $802 million, that an "inflation adjustment" boosts that figure to $1 billion, and that more than a decade has passed since, I'm not so sure the number is out of line.

We saw how negatively Big Pharma stock prices were crimped by the "patent cliff" worries of a few years back – when scads of blockbuster drugs were coming off patent. And we regularly watch how investors badly savage a stock when a clinical trial goes awry or when a new drug application is denied by the U.S. Food and Drug Administration (FDA).

You can quibble a bit about the Tufts estimate. But to me, the message is clear: Innovation is more valuable than ever before – in biotech, information tech, and even in "boring" old consumer-focused and industrial companies.

And innovation has a greater impact on your investment returns than ever before. Effective, successful innovation will reward you with gains that far exceed the market averages. Wasted innovation – that is, money wasted on errant R&D or innovation that's never commercialized – will drown you in the red ink of stocks in a freefall.

And I guarantee that the "Spirit of Prof. Barnard" would agree with everything I've said here.

Top companies are employing creative strategies to innovate.

Just look at Abbott Laboratories (NYSE: ABT), the Big Pharma player whose shares have gained 42% (48% with dividends), since we recommended it back in June 2012.

Inside the Biotech "Skunk Works"

In the June 13, 2012, Private Briefing report "Two Companies for the Price of One," we recommended readers invest in Abbott ahead of a corporate spin-off that was scheduled to occur at the end of that year.

The breakup created two companies: Abbott, now a healthcare-products company, and AbbVie Inc. (NYSE: ABBV), a research-based pharmaceutical firm whose product roster includes Humira, the arthritis blockbuster that's the best-selling drug in the world.

The recommendation has played out even better than we expected. In addition to the gains you've reaped from Abbott, AbbVie has soared 89.2% (99% with dividends).

Nice profits, to be sure. And that's only the start.

Recent reports show that both stocks offer a hefty long-term upside.

Just yesterday, in the second of the two news stories I promised to share with you, the San Francisco Business Times recounted how a unit of the 69,000-worker Abbott Labs is using a "start-up" mentality to rev up innovation.

The unit, the Santa Clara, Calif.-based Abbott Vascular Inc., wanted to create a type of surgical "scaffold" that could open the arteries that transport blood away from the human heart. A scaffold looks like a tube-shaped skeleton that slides inside the artery. It functions like a "stent" – helping restore blood flow and keeping the artery open to heal. But once that job is done it breaks down and is absorbed into the body.

"The knotty problem was that [Abbott] wanted to go beyond old-school stents, onto which the gunk that swims through the blood could attach and ultimately plug the arteries again," Business Times reporter Ron Leuty wrote. "The problem is not so much technical as one that centers on elasticity, radial strength, and the properties of materials that combine to clear an artery, and yet can melt away."

As a Big Pharma heavyweight, Abbott could just go out and buy the technology somewhere. But as Prof. Barnard counseled me time and again, the ability to innovate quickly and efficiently has an innate value, too. That's why the company wanted to create its own medical device.

So the parent company set up a medical-device version of the famed "Skunk Works," the miracle-working aviation unit of Lockheed Martin Corp. (NYSE: LMT) that created the supersonic SR-71 Blackbird, high-flying U-2 spy planes, and the F-117 stealth fighter.

It installed the Abbott Vascular innovation team in Mountain View, about 10 miles from the rest of the group in Santa Clara. And just as if it were a regular venture-capital firm, the parent gave the team funding and established "milestone" goals.

And it gave the team one directive: THINK BIG.

"We wanted them to move fast, fail fast," Chuck Foltz, the head of Abbott Vascular, told the Bay Area business newspaper.

It took eight years to get from launch to initial approval in Europe – a faster-than-normal cycle time for a medical device (which has to undergo testing, just like drug candidates).

The product has been approved in 60 countries already.

But this isn't "old news."

Over the next 18 months, Foltz says he's expecting regulatory approvals in the United States, China, and Japan – three of the most important device markets in the world.

The payoff from this project goes well beyond the revenue the device generates. The innovation team was absorbed back into the 7,000-employee Abbott Vascular, meaning the innovation lessons will permeate the company. It's also seeking to embrace more of the Silicon Valley innovation mentality.

After all, Abbott Vascular recently snapped up Menlo Park, Calif.-based medical device maker Topera Inc. for $250 million and has a potential deal to buy the Santa Clara medical-technology firm Advanced Cardiac Therapeutics Inc. And it's watching what its neighbors are up to.

"We like being here," Foltz told the business journal. "That's innovation the Silicon Valley way."

Putting the Grim Reaper Out of Work

AbbVie, the other company to emerge from the Abbott breakup, is also traveling a unique path to innovate.

As we mentioned back in September, AbbVie has linked up with Google Inc. (Nasdaq: GOOG, GOOGL) to launch Calico Life Sciences LLC, a life-sciences company that's been launched to focus on anti-aging research. (Back in September, Time magazine actually ran a cover story called "Google vs. Death.")

And Calico has grabbed some of the best talent available.

Google started by hiring Arthur Levinson, the chairman of the Apple Inc. (Nasdaq: AAPL) board and former CEO of Genentech Inc., to be Calico's chief executive officer.

Levinson is viewed as a senior statesman in the biotech sector. The reason: Under his stewardship, Genentech emerged as one of the top cancer-drug developers on Earth.

Soon after assuming this new role, Levinson persuaded Roche Holding Ltd. (OTCMKTS ADR: RHHBY) R&D guru Dr. Hal V. Barron to join him as Calico's research chief.

The top-tier recruiting continued after that. Cynthia Kenyon, an oncology professor at the University of California, San Francisco, was promoted from part-time advisor to vice president of aging research.

And Jonathan W. Lewis, a veteran of UCB SA (EBR: UCB) and Genentech, came in as vice president of new business development. His mandate: Support "the company's growth through partnerships and collaborations."

Calico remains a bit of a mystery.

Even after bringing aboard all this executive firepower, Calico remains reluctant to talk about its plans. As FierceBiotech reported, revelations about the company's mission were limited to such statements as "[Our plan is to] harness advanced technologies to increase our understanding of the biology that controls lifespan [using] that knowledge to devise interventions that enable people to lead longer and healthier lives."

According to the company, achieving that goal "will require an unprecedented level of interdisciplinary effort and a long-term focus for which funding is already in place."

But with the financial firepower of Google to back it, expect Calico to be a real difference-maker – meaning AbbVie will be a big beneficiary.

Both Abbott and AbbVie are companies you'll want to own for the long haul.

Here's why.

These Shares Have Paid for Decades Now

Abbott Labs is a "Dividend Aristocrat," an index of 54 companies that have raised their dividends for at least 25 consecutive years. Abbott's first dividend increase was in 1973, so you're looking at 41 straight years of boosted payouts.

Dividend Aristocrats have historically outperformed the general market – while posing lower risk. In the last 10 years alone, the aristocrats have returned 10.67% a year – well ahead of the 8.38% annual gain of the Standard & Poor's 500 Index.

Despite its run, Abbott is still cheap. The stock is trading at a slight discount to the S&P 500, even though the company's rate of earnings growth far exceeds the broad index. The stock's 2% yield is only slightly higher than the 1.9% yield of the S&P. But the company should be able to boost earnings at a rate of 10% a year or better (12% in the most recent quarter) – which far exceeds what you'll see in the broader market.

Wall Street is getting interested, which is good for folks already holding the stock. And its reasoning, not surprisingly, closely follows ours.

On Oct. 29, Deutsche Bank AG (NYSE: DB) analysts upgraded Abbott from a "Hold" to a "Buy" – and boosted its target price from $42 to $54.

Following a meeting with Abbott's management, Deutsche Bank analysts "walked away with greater confidence that the recent and upcoming portfolio actions positions the company for the level of growth it has aspired to [in the aftermath of] the spin-off of AbbVie – that is, mid-to-upper-single-digit sales [growth] and double-digit EPS growth," the investment bank wrote in a note to its clients. Moreover, "we believe Abbott can sustain mid-to-high-single-digit sales growth and 10% to 12% EPS growth. Given this [prospect for growth, coupled with its strong] balance sheet and cash flows, we believe the stock should trade at a premium valuation and there is significant upside from current levels."

And that means the stock should feature a higher valuation – and a higher price. Add in Abbott's proven ability to innovate – the "I-Code" indicator of future profits – and you've got yourself a solid long-term profit play.

And thanks to its approach to innovation, AbbVie is just as revved up.

On Nov. 14, Deutsche Bank initiated coverage on AbbVie with a "Buy" rating and a target price of $80 a share.

Both these stocks are solid buys.

Source : http://moneymorning.com/2014/11/21/two-biotech-stocks-set-to-double-on-one-powerful-catalyst/

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