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Biotech 3Q Won't Sparkle, But Market Bottom Is Possible
Analysts don't expect sparkling third-quarter earnings from the sector, but they don't see a washout either.


1 Oct 2002

CHICAGO -(Dow Jones)- Although the third quarter was another losing one for biotech stocks, the group outperformed the Nasdaq Composite Index for the first time in a year, giving some hope for stabilization heading into the earnings period.

Analysts don't expect sparkling third-quarter earnings from the sector, but they don't see a washout either.

Biotech stocks, as measured by the American Stock Exchange's Biotechnology Index (BTK), fell 8% in the quarter compared with nearly 20% for the Nasdaq index.

It was the first time since the third quarter of 2001 that biotechs outdueled the larger index over a full quarter.

But the 8% decline looked positively sunny compared with biotech's 30% decline in the second quarter and 15% decline in the first quarter.

Biotech stocks also did a little better than straight pharmaceuticals during the third quarter. The AMEX Pharmaceutical Index (DRG) fell 9%.

Some key drug approvals - notably of Amgen Inc.'s (AMGN) Aranesp for oncology use - provided underlying support for the biotech sector.

"The sector is doing very well fundamentally," said Matt Geller, a CIBC World Markets Corp. analyst, who's a bull on the group. "People had grown too pessimistic and the fundamentals have improved. That's a good combination."

Faster Approval By FDA

President George W. Bush's recent nomination of Dr. Mark McClellan to head the U.S. Food and Drug Administration could give the sector additional tailwind. The FDA has been leaderless since Bush took office.

"With a commander in chief to guide the boat, that's a big plus," said David Saks, chairman and chief investment officer of the Saks MedScience Fund, a health-care hedge fund at Ladenburg Thalmann & Co.

A new FDA leader could bring more predictability to the agency and its drug approval process, analysts said, making biotech a less scary place for investors to put their money.

In addition, there's optimism that Congress will get some sort of prescription drug bill approved before the end of the year, and there's the usual talk about how the fourth quarter tends to be a strong one for biotech.

Watch Bellwether Amgen

Still, the sector has been under extreme pressure for some time.

The AMEX Biotech Index is down nearly 50% since a year ago, a worse performance than the Nasdaq composite over the same period, although not by much.

A weak pharmaceutical sector, investor concern about the FDA approval process and some notable drug failures have all weighed on the group.

Probably the key stock to watch as far as third-quarter earnings is Amgen, which has become an industry bellwether thanks to its success with several drugs.

Amgen got a boost in July when the FDA approved its Aranesp drug for the treatment of chemotherapy-induced anemia. Previously, the drug was approved solely for anemia associated with chronic renal failure.

CIBC's Geller believes sales of Aranesp might total $100 million in the third quarter after getting off to a slow start following last year's initial FDA approval due to lack of an oncology indication.

Analysts think Aranesp has definite potential as an oncology drug.

"We believe that Aranesp will reach peak sales of $2 billion, primarily by capturing share of the oncology market from Johnson & Johnson (JNJ) and by penetrating the European cancer and dialysis markets," said Eric Ende, a Merrill Lynch & Co. analyst, who has a buy rating on the stock.

Ende doesn't own shares, but Merrill does have an investment banking relationship with Amgen.

During Amgen's third-quarter earnings call, scheduled for Oct. 23, analysts will listen closely for any clues about the timing for approval of a Rhode Island facility to manufacture Enbrel, its rheumatoid arthritis drug.

Amgen cut its estimate for 2002 Enbrel sales two months ago in part because of capacity restraints.

Analysts surveyed by Thomson First Call expect Amgen's third-quarter earnings per share to rise just 3% to 31 cents.

But Ende, of Merrill Lynch, said EPS growth is likely to reaccelerate to 20% before too long based on more manufacturing capacity for Enbrel, the new cancer application for Aranesp and strong sales of Neulasta, a drug that stimulates white blood cells in chemotherapy patients.

Neulasta was approved by European regulators in August and by the FDA earlier this year.

Biogen's Amevive To Get A Close Look

Another key company to watch is Biogen Inc. (BGEN), whose shares have been under intense pressure the last few months due in part to concerns about the company's Amevive drug for psoriasis.

An FDA panel recommended approval for the drug in May, but the FDA in September decided to give Biogen's application a six-month review, putting off possible approval until the first quarter. That's later than investors had previously expected.

Analysts are cautious about the ultimate market potential for Amevive, noting that there have been concerns about T-cell depletion associated with the drug and competition from Genentech Inc.'s (DNA) Raptiva and Amgen's Enbrel (which is in clinical trials for use on psoriasis patients).

A survey of analysts by Thomson First Call pegs Biogen's third-quarter earnings at 35 cents a share, down from earnings of 49 cents a share a year ago. Biogen reports Oct. 18.

Another big biotech company whose earnings could be on the weak side is MedImmune Inc. (MEDI), which probably won't be able to get its FluMist nasal flu vaccine approved in time for this year's flu season.

The product is expected to be a big winner once it gets approved by the FDA, but that looks more likely to happen early next year.

Geller, the CIBC analyst, who rates MedImmune a sector outperformer and doesn't own shares, says there's an outside chance approval could come in November, which would be in time for the flu season.

"We've kept that in our thoughts, but not our numbers," Geller said. CIBC World Markets doesn't have a banking relationship with MedImmune.

First Call's survey has MedImmune's third-quarter loss per share at 14 cents, a decline from a 9-cent loss in the third quarter of 2001. The company reports Oct. 24.

But analysts expect Genentech, another biotech powerhouse, to post a 15% rise in third-quarter earnings per share to 23 cents, despite some bad news during the quarter.

Last month, Genentech announced that a trial for its Avastin drug failed to achieve its end points in breast cancer patients. The drug is in Phase III trials for colorectal cancer, and analysts hope for better results.

By the end of the year, Genentech - in partnership with Xoma Ltd. (XOMA) - should be ready to file for approval of Raptiva, a psoriasis drug, Geller said.

It's also on schedule for a filing before the year's end of asthma drug Xolair, in which it is partnered with Novartis AG (NVS) and Tanox Inc. (TNOX).

Genentech reports earnings on Oct. 9.

Some Small Players Worth Watching

Although big names get much of the attention, analyst David Witzke of Morgan Stanley says smaller companies like Human Genome Sciences Inc. (HGSI), Myriad Genetics Inc. (MYGN), Lexicon Genetics Inc. (LEXG) and Tularik Inc. (TLRK) also deserve a look.

These companies tend to be earlier in the drug-development stage than their bigger rivals, but Witzke sees them as attractively valued based on a number of newly-discovered molecules and "rapidly emerging" pipelines.

"We believe that investors will begin to gain a greater appreciation for the drug-discovery capabilities of many of these companies," Witzke wrote in a report to clients Tuesday.

He added that "there are catalysts in place" for a general biotech rally in the fourth quarter of 2002 and the first quarter of 2003.