Interactive Investor

Ian Cowie: plenty of value in this recession-proof sector

15th December 2022 09:11

Ian Cowie from interactive investor

Our columnist explains why a blockbuster deal shows there’s plenty of bargain opportunities in this sector, which DIY investors can take advantage of through investment trusts.  

This week’s blockbuster $26 billion (£21 billion) agreed bid to buy a Dublin-based biotechnology business is the biggest the sector has seen this year and boosts speculation that further acquisitions are imminent. Here and now, this deal is just the medicine for me because the target company, Horizon Therapeutics (NASDAQ:HZNP), happens to be the biggest holding in one of my investment trusts, International Biotechnology (LSE:IBT).

Better still, the buyers, Amgen Inc (NASDAQ:AMGN) are paying a premium of nearly 50% to last month’s market price. Horizon Therapeutics shares surged 15% higher on Monday (12 December) after spiking 23% last Friday (9 December), having trended upwards since the company said it was in three-way takeover talks with the aforementioned American giant, Amgen; its French rival, Sanofi SA ADR (NASDAQ:SNY); and the biggest healthcare company in the world, Johnson & Johnson (NYSE:JNJ).

Neither of the two unsuccessful suitors is likely to shun seeking bargains in this sub-sector if valuations remain depressed relative to its ‘recession-proof’ opportunities. People don’t stop needing medical treatment, just because the economy has a bad year.

The agreed bid brings Amgen two fast-growing drugs, the gout treatment Krystexxa and the thyroid eye disease treatment Tepezza. Crucially, both medicines have “orphan drug designation” from the American Food and Drug Administration (FDA), which is intended to stimulate pharmaceutical innovation to treat rare illnesses.

Orphan status can confer market exclusivity and means these medicines are unlikely to affected by Medicare restrictions, intended to squeeze drug prices as part of America’s Inflation Reduction Act (IRA). Amgen’s head of commercial operations, Murdo Gordon, explained: “Given the IRA, the strategic importance of being in these kinds of disease areas with products that have low Medicare exposure and orphan designation, makes Horizon Therapeutics even more attractive.”

While hardly a household name, Horizon Therapeutics’ gout treatment Krystexxa brought in sales of $565 million last year and it claims they might reach $1.36 billion by 2028. In total, the company forecasts net sales of between $3.59 billion and $3.61 billion, and adjusted earnings before interest, tax, depreciation and amortisation of $1.32 billion to $1.34 billion for full-year 2022.

Closer to home, International Biotechnology Trust had 13.5% of its net asset value (NAV) invested in Horizon Therapeutics last week. No wonder this £303 million investment trust, founded in 1994, is the top performer in the Association of Investment Companies (AIC) ‘Biotechnology & Healthcare’ sector over the last decade with total returns of 343%.

Less happily, its five-year returns fell away to 38%, followed by a loss of less than 1% over the last difficult year. Despite an attractive dividend yield of 4.6%, after it increased investors’ income by an annual average of 6.4% over the last five years, the shares remain priced at a 4.2% discount to NAV.

Worldwide Healthcare (LSE:WWH) is my ninth-most valuable shareholding and the second-best performer in this sector over the last decade, with a total return of 317%. However, Worldwide Healthcare’s performance has fallen away even more sharply recently, with total returns of 33% over five years and a loss of 9% over the last year. Unlike IBT, WWH offers a measly yield of 0.8%, which may explain its shares trading at a bigger discount of 7.5% below NAV.

Meanwhile, investors who prefer to place greater emphasis on more recent performance may prefer Polar Capital Global Healthcare (LSE:PCGH), which leads this sector over the last five and one-year periods, with total returns of 70% and 10%. PCGH’s 10-year return is 210%, but it yields just 0.6% income and trades on a 5% discount to NAV.

IBT co-managers Ailsa Craig and Marek Poszepczynski claim the trust should benefit from further mergers and acquisitions (M&A). Craig said: “Valuations in the biotech sector reduced dramatically towards the end of 2021. However, IBT was fortunate enough to have seven companies in its portfolio acquired during its fiscal year that ended in August 2022.”

Poszepczynski added: “With fundamental innovation at smaller biotech companies remaining robust but valuations looking attractive, there is a strong chance an M&A buyer’s market will emerge, with big pharmaceuticals and big biotech companies looking to replenish their pipelines of expiring product patents with new innovative products that might have been considered overvalued in the past.”

Big pharmaceutical companies are sitting on large piles of cash since the Covid crisis and are using it to replenish their drug pipelines. For example, Johnson & Johnson said it had struck a deal to acquire cardiovascular technology group Abiomed for $16.6 billion last month. Earlier this year, Pfizer Inc (NYSE:PFE) said it had agreed to buy the immunology specialists Biohaven for $11.6 billion.

Whether M&A activity continues to boost returns for ‘Biotechnology & Healthcare’ investment trusts from current depressed valuations, this sector provides an effective way for shareholders to do well by doing good.

Research costs billions and much of the capital employed is destroyed because most new drugs never reach the market. Meanwhile, ‘Big Pharma’ gets a bad press but it wasn’t politicians or journalists who found the Covid vaccine.

Ian Cowie is a freelance contributor and not a direct employee of interactive investor.

Ian Cowie is a shareholder in International Biotechnology Trust (IBT), Pfizer (PFE) and Worldwide Healthcare (WWH) as part of a globally diversified portfolio of investment trusts and other shares.

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