Biotech stocks rout beginning to reveal pockets of value

By Rodrigo Campos and Caroline Valetkevitch

NEW YORK (Reuters) - Predicting when the bear market in biotech stocks will hit bottom is a hazardous prospect, but one gauge that factors in the rapid profit growth estimates for many of these companies suggests several are starting to look attractive.

The Nasdaq Biotech index (NAS:^NBI), a primary victim of the meltdown in so-called momentum stocks, has dropped more than 20 percent from its record high in late February. In April alone, only around half a dozen of the 121 stocks in the index have managed to hold their heads above water.

Among some of the sector's names, however, the selloff is starting to look overdone, according to an analysis of Reuters data.

"It definitely piques your attention, and you should look at these stocks more closely now," said Giri Cherukuri, head trader at Lisle, Illinois-based OakBrook Investments LLC, which owns momentum stocks. "You don't want to wait too long, (the selling) has been so dramatic it's worth looking into."

Biotech is among the hardest sectors to value using fundamentals such as profit and cash flow.

Only about a quarter of the Nasdaq sector index members are profitable, and even fewer consistently so. Most of the rest represent bets on a drug or therapy still in the development or approval process, with prospects for sales and profits still far in the future.

Indeed, on a straight-up price-to-earnings basis, biotechs continue to look expensive, even with the sharp contraction in P/E multiples across the group courtesy of the selloff. At almost 21, the index's 12-month forward P/E is on par with the Russell 2000 (.TOY) index of small caps but is pricey compared with the S&P 500's 14.9.

But when profit growth estimates are added to calculus, using the so-called PEG ratio, the picture can change. In such cases, a high P/E can be offset by earnings growth estimates that are often solidly in the double digits.

In general, stocks with a PEG ratio below 1 are considered to hold a higher value than the market is currently giving them.

And on that basis, more than 20 Nasdaq biotech components have forward 24-month PEG ratios below the 1.0 handle, based on an analysis of Thomson Reuters StarMine data. That includes Biogen Idec (NSQ:BIIB), United Therapeutics (NSQ:UTHR) and Gilead Sciences (NSQ:GILD). Emergent Biosolutions (NYS:EBS), not in the Nasdaq index, is another biotech with its PEG below 1.

"You throw that growth (expectation) up and it looks kind of OK and comforting," said Kim Forrest, senior equity research analyst at Fort Pitt Capital Group in Pittsburgh, which owns biotech Amgen (NSQ:AMGN).

Don't be fooled. These remain high-risk stocks, with a lot of uncertainty generally in the biotech business model, she said. Anyone stepping into buy while the downdraft persists could be "catching the proverbial falling knife."

"This is extremely speculative. You have to know the entire landscape," she said.

HIDDEN VALUE

Gilead, the sector's biggest stock with a market capitalization of around $103 billion, is a poster child for the gut-wrenching ride that investing in this sector can entail.

Last December, the company unveiled impressive late-stage data for its once-daily combination pill to treat hepatitis C. The stock took off to cap a stellar year of more than 100 percent price increase.

Then three weeks ago, U.S. lawmakers asked it to explain the drug's $84,000 price tag. The stock fell nearly 5 percent that day, helping to propel what had been a minor downdraft in biotech names into a full blown rout.

Now, at $68.17, around 19 percent below its February 25 record close of $83.95, Gilead looks undervalued when measured with a two-year forward PEG ratio of just 0.17. That ratio dips even lower, to 0.15, based on the growth rate assigned by only the most accurate analysts covering the stock, Thomson Reuters StarMine data showed.

Meanwhile, Biogen's PEG ratio is 0.8, Emergent Biosolutions is 0.41, and United Therapeutics is 0.23. The lower the number, the more undervalued the shares may be relative to profit growth forecasts.

Three of these four - Gilead, Emergent and United Therapeutics - also are trading below their StarMine intrinsic values, a metric that factors in the growth estimates from Wall Street's most accurate profit forecasters.

So far, the selloff has come in a near-vacuum of fundamental news on these companies. That will soon change, with earnings season kicking into high gear and quarterly results due in the coming days and weeks.

"If you see solid earnings for some of these companies, that would give some assurances for people to come in and buy at these levels," said Cherukuri, the OakBrook Investments head trader.

(Reporting by Caroline Valetkevitch and Rodrigo Campos; Editing by Dan Burns and Grant McCool)