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Our veteran stock-picker turns his searchlight on potential winners in the field of medical research

26 November 2016

9:00 AM

26 November 2016

9:00 AM

Any medically or technically unqualified investor who dips a toe into the pharma and healthcare sector should do so with due humility — even more so than in less specialised stock-picking. For a start, this is a huge sector embracing many esoteric aspects of science. It’s also a sector with which we all feel empathy, for obvious reasons, and may thereby be predisposed to invest in it. But beware of emotion when picking stocks.

Government agencies, universities and charities are all conducting vital medical research. So, too, are global pharma conglomerates and a myriad of smaller companies — many of the latter yet to float, so inaccessible to the private investor. But it’s estimated that as much as three quarters of all research investment is wasted. Unsuccessful research is not publicised, not least in case it has adverse impacts on further fundraising for the project or venture concerned.

Perhaps the system used in mineral exploration, which requires all exploration results, successful or otherwise, to be recorded by the authority that gives permission to explore, could be adapted for pharma research too: duplicating failure would then become much less common.

In short, the amounts of money employed in the healthcare and pharma sector are huge, and competition is intense. Timescales are very long, and finding winners requires prodigious knowledge and luck.

Making effective drugs available to all at accessible prices is one obviously desirable path for the industry. ‘Big Pharma’, having spent hundreds of millions developing new treatments, are obviously keen to recover their investment as quickly as possible. Until recently, patent law protected the successful developer and allowed it to charge whatever the market would pay. These days, however, social media as well as governments exert pressure to allow new drugs to be available at modest prices in poorer countries. That happened to Gilead, the US pharma giant highlighted below: the company’s reward for its generosity was a collapse of its share price. So now the big question is, who will bear the costs of research and development, often over ten years or more, if substantial returns are becoming less predictable?

The last few years have seen Big Pharma retreat from the research and trialling that is the start of the commercialisation process — encouraging a proliferation of smaller companies, often start-ups by teams of scientists. These ventures are then bought out by bigger companies when next-stage finance and marketing skills are required. This small company arena is where big profits can be made — but picking winners is analogous to betting on the Grand National.

Areas of excitement that the stock picker should be aware of include robotics and artificial intelligence, which could transform surgical techniques and diagnostics. Another is bacteriophages — literally bacteria eaters, pioneered by the late Grace Filby, a British teacher turned microbiologist, as an alternative to antibiotics.

Research in this area might yet give the answer to the growing problem of antibiotic resistance. Genomics, immunotherapy and virus blockers are other areas of science where fortunes will be made — or lost. And there are many others beyond the ken of your humble veteran investor.


As in every investment choice, timing is important. Many excellent companies are presently selling at historic highs. My instinct is to pass by and leave others to climb on those bandwagons: GlaxoSmithKline and AstraZeneca are examples, both having had a substantial price boost as beneficiaries of
wBrexit’s devalued pound. Lower down the industry’s hierarchy, it’s important to be sure a company is either profitable now, or at least will be solvent for the next two years or so.

With these guiding principles in mind, here are a few names that have good chances of surviving and thriving in this huge, complex and exciting sector.
 
(Prices as at 16 November)

 

GILEAD

 
Share price $76.50
Market cap £83bn
 
This large, hitherto well-respected US maker of HIV and hepatitis treatments has served investors well over recent years, but hit turbulence in 2016. Its shares declined from a high of $102 in late April to a low of $72 in mid-October — primarily due to weak sales revenues for its Harvoni hepatitis C drug. However, it has many other successful and tried drugs as well as a development pipeline of others in areas such as liver and cardiovascular disease, oncology and inflammation. Currently the shares sell at around seven times earnings, a rating that anticipates no growth.
 
A company of the size and quality of Gilead, developing drugs that the world needs, will surely grow and its price recover. Some Wall Street analysts say it could go to $135, but a return to $100 would still be a big win.

 

SMITH & NEPHEW

 
Share price £10.77
Market cap £9.45bn
 
Thomas James Smith would surely be amazed to see his Hull-based pharmacy business today. He started it 160 years ago and on his death in 1896 his nephew Horatio took over. It’s now a world leader in medical technology, with 15,000 employees worldwide. Advanced wound management, robot-assisted orthopaedic surgery, trauma and sports medicine are just some of the areas using equipment made by Smith & Nephew. It should generate over £800 million profit this year, putting it on an unexacting 13-times p/e ratio. And it should be a major beneficiary of the looming era in which robotics and artificial intelligence start to do more and more of the surgeons’ and diagnosticians’ work. Then there are constant rumours of a possible takeover — though Thomas and Horatio would never approve, and their influence has prevailed so far.

 

ERGOMED

 
Share price £1.26
Market cap £50.2m
 
A rarity in the sector we’re looking at: Ergomed has a low-risk investment strategy but potential for high returns. It’s also profitable and debt-free. So what does it do? It offers services to pharma companies, mainly advising on how to conduct safe clinical studies and trials leading to regulatory approval. For this it charges fees, but also negotiates a carried interest in the sales of the drugs approved. It had an order book earlier this year of over £60 million and cash in the bank of £4 million; it also raised £9 million at £1.37 in a private placing connected with the acquisition of two small German data analytical specialists. This seemed to surprise the market and the shares have been drifting around £1.20 ever since — despite German broker GBC suggesting they should be double this price. On this one at least, I’m with the Germans.

 

ALLERGY THERAPEUTICS

 
Share price 21.4p
Market cap £126m
 
Ah, yes, very much a personal choice as I rub my itchy eyes and sneeze. However, here’s another rare bird in the small-company biopharma space: a profitable one. For the year ended in June, revenues of £51 million were up by 19 per cent, producing operating profit of £4.3 million. Thanks to a fundraising, the company has a cash balance of £23 million which should see it through the next few years. One of its immunotherapy allergy vaccines, Pollinex Quattro Grass, will go through Phase 3 trials in the US for a second time early next year, and there is optimism that Allergy Therapeutics could still be first in this $2 billion market. The company has many products which are sold mainly in Europe, other vaccines in the pipeline and impressive management. With over 25 per cent of Europe’s population allergic to something, this is surely one to tuck away.

 

 

ANGLE

 
Share price 58p
Market cap £44m    
 
A return to a company mentioned here in May. Patience is often necessary with smaller companies — and I recommended Angle at 65p with a health warning, so to speak, about its diminishing cash position. Almost immediately, Angle successfully sold a 25 per cent stake for £10.2 million. This cash should be enough to get its blood biopsy system Parsortix accepted by clinicians and through regulatory procedures in Europe and the US.

Angle has many joint ventures with major hospitals and research centres that are assessing the advantages of Parsortix, which can identify cancerous cells in the blood, even if in minute concentrations. This blood test is quicker, cheaper and less invasive than other diagnostic procedures. The worldwide market could be in the billions of pounds, but Angle doesn’t need all of it to be a winner.

 

INTELGENX

 
Share price $0.92 (Cdn)
Market cap £35.6m
 
This Canadian company is a leader in ‘oral thin film’ manufacture. A degradable film is impregnated with an approved drug and placed on the tongue. This has advantages, including faster delivery and no need for water: it is particularly helpful for the old or young when swallowing is a problem. The company is developing many joint ventures with approved drug manufacturers; it recently sold one back to the partner for $8 million, so addressing the usual lag of revenues.
 
Part of the reason for a loss last year of around $5 million was the building of a unique machine which will produce the oral film in commercial quantities. This will be commissioned in February 2017. New management and an experienced sales team have been recruited recently: the company looks ready for lift-off.


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