Biotechs start to outperform

Australian biotechs are starting to mirror the US bull run.

Things are looking up for Australian biotech stocks, with the sector on the cusp of a multi-year bull run if indications from their United States peers are anything to go by.

Biotech stocks listed on the US NASDAQ are running red hot, with the group delivering a total return of 50.6% since the start of the year, nearly 70% ahead of the broader NASDAQ Index.

Local biotech experts haven’t been this excited in a long while, as the rise in US life science stocks is fuelling speculation that it is Aussie biotechs’ turn to shine. Indeed, our sector is only just starting to pull ahead of the market.

While retail investors probably wouldn’t have been hurt too much in the past by ignoring biotech stocks, locally listed medical innovation companies have matured significantly in the last few years. As such, they are fast becoming an important part of any portfolio in the current environment where profit growth is getting increasingly harder to generate.

The earnings potential for these companies is generally not dependent on economic cycles. If they achieve an important milestone they will be re-rated regardless of economic conditions, with ageing demographics supporting demand for medical products and services.

Australian retail investors should be looking at life science companies, as never before have so many of them been this close to, or in, commercial production.

The increasing importance of biotech stocks is not lost on sophisticated investors, and the upswing in sentiment is fuelling a raft of new life science floats in Australia. This is much like what has occurred in the US, with 41 new listings worth around $US3 billion hitting the NASDAQ since the start of 2013.

This marks the second-largest initial public offer (IPO) boom for the sector in US history. The only float boom that has been bigger to date was during the height of the technology stock bubble in 2000, when 63 IPOs raised $US6 billion, according to the chief investment officer of Biotech Select Fund and research principal of Bioshares, Mark Pachacz.

“The US biotech market goes in a five-year cycles. It started in 1982 with the advent of genetic engineering,” says Pachacz.

“The last one was meant to be in 2007-2008, but we missed that because of the GFC [global financial crisis]. So, we’ve got 10-years of money going into the sector and nothing coming out in terms of IPOs.”

The life science IPO fever is also starting to grip Australian investors, who have poured a record $419 million into newly listed companies in 2013. Fertility services company Virtus Health (VRT) led the charge in June this year, with the stock up 51% since its public debut.

The amount raised in IPOs is likely to swell further, with incontinence monitoring company Simavita and motion analysis device developer dorsaVi both looking to list before Christmas.

While the number of deals is still low, the average amount raised per float is increasing. That is a positive sign for our market as it indicates a growing level of maturity and sophistication that has been lacking before.

“I think ultimately price raises and valuations overseas must translate into something,” says investment director for DMP Asset Management, Julian Mitchell.

“There seems always to be a value arbitrage between how life sciences are valued in America and Australia, but you need to make sure you are comparing apples with apples as we are generally a less-developed market.”

However, one cannot immediately assume that a 50% surge in US biotech stocks will automatically translate to a similar gain here because of the difficulty in making comparisons between the two markets.

Offshore fund managers who spoke with Eureka Report are reluctant to draw too much of a connection.

London-based Polar Capital complains that few Australian biotechs make the effort to schedule face time with the investment community there, and that is why its new biotech fund with $US550 million in funds under management is focused on opportunities in the US, UK and Europe instead.

“Without regular contact and exposure to the stories it is difficult to build familiarity, especially as due diligence is hampered by distance and time,” writes Polar’s fund manager David Pinniger in an email to Eureka Report.

Edinburgh-headquartered Standard Life Investments is also not taken with Australian biotechs, even though the fund, which has $311 billion in assets under management, has a bullish outlook for the global biotech sector.

“An area that we grapple with is trying to understand what the sustainable competitive edge [is] of many small Australian biotechs in the global industry,” writes its investment director Will Malcolm.

“The R&D [research and development] dollars put to work by the Australian companies is pretty small in the context of the better capitalised and arguably more sophisticated North American sector.”

He goes on to say that by the time an Australian biotech is successful enough to catch his eye, it is usually too late as the company is often taken over by a global player.

These are valid arguments, but I believe they are becoming less of an issue. International investor interests in Australian life science companies have increased materially over the last two to three years, with these investors popping up on the registers of biotechs such as Starpharma Holdings (SPL), Phosphogenics (POH) and Mesoblast (MSB).

Courting overseas investors

If Australian life science companies make the effort to market themselves to overseas investors, and assuming they have a commercially attractive innovation, they are likely to find a willing audience.

“From my own experience, and I know from experiences of other similar sorts of [Australian] companies, we have found it to be a pretty productive exercise,” comments the chief executive of Starpharma, Jackie Fairley. Two thirds of Starpharma’s institutional investors are currently from the US or Europe.

However, the Australian life science sector needs a catalyst if it is to pull further ahead of the broader market – and it may just get the kick it needs in the very near term, predicts Pachacz.

“What is really going to set this sector on fire is an acquisition or a major licensing deal, and I think we will see one in the next three-months,” he adds.

His pick for a likely takeover target is Universal Biosensors (UBI), which developed blood glucose and coagulation testing devices.

Its glucose tester is licensed to LifeScan, a Johnson & Johnson subsidiary; and its coagulation device is licensed to Siemens.

Universal Biosensors is under pressure, with the stock slumping 41% this year to 54 cents – its lowest level since the darkest days of the GFC back in March 2009.

A delay in the launch of its coagulation tester and the loss of its test strips manufacturing contract for the LifeScan device are the key drivers for its underperformance, but the market is under appreciating the earnings potential of Universal Biosensors, which receives 1 cent for every test strip that LifeScan makes.

I rated the stock “outperform” in my article on September 4 and the stock has shed 22% since for the reasons outlined above. However, I believe the stock will be a lot higher over the next 12 months to where it is today and I re-iterate my recommendation on the Universal Biosensors.

As for the company likely to strike a major licensing deal, Starpharma is a standout. Preclinical data released by the biotech over the past few months indicates that its dendrimer technology can significantly improve the efficacy and effectiveness of a number of common anti-cancer drugs.

This means big pharmaceutical companies that own these drugs will be interested in some partnership deal as the new formulation with the dendrimer means they can extend the patent life of their blockbuster drugs, which have, or are coming off patents.

As I stated in my July 17 article, and I’ll say it again: I believe the stock can double in value over the next year or so.

Another life science stock that is worth buying is Nanosonics (NAN). The company has developed a device to disinfect ultrasound probes more effectively and is expected to deliver its maiden profit in the current financial year.

If history is any guide, a company like Nanosonics is likely to keep rallying after it posts its full-year results in August next year even though the market is anticipating the good news.

Think big, go smalls!

List of "outperform" recommendations on the Uncapped 100

NameCodeArticle datePrice*Article Name
eBetEBT26-Jun-13$1.130Small cap with biggest earnings upgrade
Silex SystemsSLX03-Jul-13$2.320Why a dog can be an investor's best friend
NewsatNWT03-Jul-13$0.400Why a dog can be an investor's best friend
Tiger ResourcesTGS03-Jul-13$0.190Why a dog can be an investor's best friend
M2 Telecommunications GroupMTU10-Jul-13$6.020Big expectations for small caps
Starpharma HoldingsSPL17-Jul-13$0.940Five bargains for under a buck
ColorpakCKL17-Jul-13$0.725Five bargains for under a buck
GI DynamicsGID17-Jul-13$0.600Five bargains for under a buck
Horizon OilHZN17-Jul-13$0.355Five bargains for under a buck
Collins FoodsCKF07-Aug-13$1.760The next dividend dazzelers
LogiCammsLCM07-Aug-13$1.470The next dividend dazzelers
NRW HoldingsNWH14-Aug-13$1.140A mining services revival?
WDSWDS14-Aug-13$0.590A mining services revival?
ThinksmartTSM21-Aug-13$0.355Biggest smalls earnings surprises
Beadell ResourcesBDR28-Aug-13$0.865Short-selling gold signals
Universal BiosensorsUBI04-Sep-13$0.680Smalls in a sweet spot
Forge GroupFGE18-Sep-13$5.230Small cap surprises for 2014
Specialty Fashion GroupSFH18-Sep-13$0.930Small cap surprises for 2014
Mint WirelessMNW02-Oct-13$0.180Four new stocks for the Uncapped 100
YTC ResourcesYTC09-Oct-13$0.260Xmas sale starts early for small caps
Ridley CorporationRIC16-Oct-13$0.850Appetisers from the agri stocks field
Wide Bay AustraliaWBB16-Oct-13$5.600Appetisers from the agri stocks field
STW CommunicationsSGN30-Oct-13$1.580Small consumer stocks at Christmas crossroads
Retail Food GroupRFG30-Oct-13$4.580Small consumer stocks at Christmas crossroads
NanosonicNAN06-Nov-13$0.830First profit, first choice for stock pickers
AMA GroupAMA06-Nov-13$0.365AMA chief's double plan
*At date of article
Source: Eureka Report

Uncapped 100 - Australia's most interesting small cap stocks

Small cap stocks covered by the Uncapped team
CodeNameRationaleMarket cap ($m)Total return 1-year (%)Sector (GICS)
MTU M2 Telecommunications Group Amazing growth story and well run company. High free float and strong insto support.1,105.0169.06Telecommunication Services
NHF NIB HoldingsOnly listed health insurer. Widely held. Good performer.1,071.1732.29Financials
GEM G8 Education Only listed childcare operator. Acquisition strategy paying off with stock delivering solid gains.927.94117.27Consumer Discretionary
MMS McMillan Shakespeare One of the best performers since the GFC, but ongoing risk of change to FBT rules is hanging over the company.904.720.49Industrials
ARP ARB Corp Well covered but good candidate for core holding due to quality management.848.7616.22Consumer Discretionary
MRM Mermaid Marine Australia Its strategically located facility on WA coast gives it a key advantage over competition in servicing Gorgon & Pluto projects.814.2814.02Industrials
AAD Ardent Leisure GroupWidely held stock. Earnings more defensive than anticipated. Good yield. Potential core holding.808.0958.85Consumer Discretionary
BGA Bega Cheese Corporate interest in Australian food companies makes the cheese maker worth following.701.62142.66Consumer Staples
SRX Sirtex Medical A shining star in the biotech space and one of the best performing stocks in 2012. Great product (liver cancer treatment) and bright outlook.681.7211.49Health Care
AUB Austbrokers Holdings The insurance broker is a strong performer. Widely held and well liked by small cap investors.677.4752.64Financials
BDR Beadell Resources Will be a very big FY14 for miner as it has to prove it aims to produce 200,000 ounces of gold a year.664.21-11.58Materials
RFG Retail Food Group Owns a number of well know franchise brands. Widely followed by instos.632.1949.85Consumer Discretionary
SGN STW Communications Group One of few companies able to benefit from online shift. Widely held and good insto support.604.5355.14Consumer Discretionary
SEA Sundance Energy Australia Analysts have a favourable take on the oil & gas explorer, but stock is still under radar of most. Sundance provides exposure to prospective Eagle Ford shale.503.0932.62Energy
CWP Cedar Woods Properties Property developer with good ROE and earnings growth track record.491.8065.4Financials
RCR RCR Tomlinson Good first half FY13 result and outlook, but will its fortunes change this year with the mining capex slowdown?483.9191.45Industrials
TGR Tassal Group Salmon farmer is finally turning a corner with an improved harvest strategy and growing demand for product.473.22132.45Consumer Staples
AMM Amcom Telecommunications Well covered junior telco but good candidate for core holding.472.0054.03Telecommunication Services
TOX Tox Free Solutions Widely held stock in the waste solutions business. Its unique because it operates in a defensive-growth niche.464.9519.78Industrials
BRU Buru Energy Substantial size but not often covered by press. Widely held with good insto support.450.53-44.69Energy
MYX Mayne Pharma Group Sizeable generic drug maker with interesting board members.442.32190.74Health Care
ACR Acrux One of the most successful Australian biotechs in recent history. Widely held by instos.438.780.32Health Care
NXT NEXTDC The cloud computing company is an IT sector darling. Fairly widely held and followed.438.1510.95Telecommunication Services
CCP Credit Corp Group Strong price run attracted good investor interest. Leveraged to any rise in loan defaults. Not well covered by press.434.5623.79Industrials
HZN Horizon Oil One of better regarded small energy stocks that doesn't receive much media attention.416.37-17.88Energy
MYS MyState Well regarded and could make good alternative to bank stocks. Has good yield and earnings growth over past few years.412.3539.93Financials
CCV Cash Converters International Strong performance is attracting investors. It's Australia's only listed pawn shop and pay day lender.409.253.77Consumer Discretionary
TGA Thorn Group One of few retail stocks that is performing well. The Radio Rentals chain owner is also well supported by instos.391.6038.23Consumer Discretionary
SLX Silex Systems Its uranium enrichment technology could become one of Australia's best innovations given its potential to change the nuclear power industry.379.66-34.8Information Technology
MOC Mortgage Choice Has a good track record and is leveraged to any housing recovery. The stock is also liquid with good insto support.366.3981.35Financials
FGE Forge Group One of the better performers in its industry. Good track record and potential core holding.360.195.72Industrials
IPP iProperty Group Worth watching as it is trying to be the REA Group of Asia.341.03104.35Information Technology
NWH NRW Holdings One of the better regarded mining & civil contractors with good track record in delivering on projects.334.67-28.48Industrials
UXC UXC Company has turned corner and enjoyed re-rating. What's next?319.3421.69Information Technology
RKN Reckon Fierce competition for cloud base accounting software puts it in firing line.295.921.6Information Technology
BNO Bionomics One of the larger cancer treatment developers in this market.284.39116.89Health Care
AEU Australian Education TrustWell performing childcare centre property owner. Good yield story and outlook. 273.7340.24Financials
GID GI Dynamics IncLargely forgotten by investors but could attract attention this year as it looks to gain US approval to use its intestinal liner on diabetics.272.987.69Health Care
RIC Ridley Corp High corporate interest in the sector and the shrinking pool of agri listed stocks make Ridley worth following.270.88-15.56Consumer Staples
IMF IMF Australia Litigation funder is unique stock. Stock not liquid but its outlook appears promising given the number of potential class action lawsuits.265.0214.08Financials
TGS Tiger Resources Future lies in its Kipoi copper mine expansion in the Congo but miner is fully funded with DRC govt holding 40% stake in tenement. Next 12mths will be interesting.253.7412.93Materials
SPL Starpharma Holdings Noteworthy for its good pipeline of innovations. Well run, widely followed.251.49-46.36Health Care
SHV Select Harvests Noteworthy for turbulent past and exposure to soft commodity market.249.76236.35Consumer Staples
GXL Greencross Acquisitive veterinary group. Good profit growth and share price performance, but gets little press.242.85108.29Health Care
VOC Vocus Communications Telecom stocks are in favour but Vocus is one of the least covered242.7077.89Telecommunication Services
AJA Astro Japan Property GroupStrong leverage to Japanese economy makes this an interesting stock to watch.242.6321.07Financials
TFC TFS Corp The sandalwood products company offers exposure to both the agri and cosmetics industry. It will start commercial harvest this year.237.01105.35Materials
SIV Silver Chef Strong jump in the share price of the equipment financing group has attracted a good following.236.4373.54Industrials
NWT Newsat Potential large cap if it can launch its own satellite in 2015.220.32-18.13Telecommunication Services
NAN Nanosonics A successful medical tech story. Should be close to turning in maiden profit with its disinfection device.219.4656.07Health Care
MXI MaxiTRANS Industries Transport equipment maker posted good interim result. Has appealing yield and growth.218.0329.03Industrials
WBB Wide Bay Australia The building society is trying to turn its fortunes around. Also worth watching for its exposure to Queensland housing market, particularly around major resource projects.213.81-5.35Financials
ACL AlchemiaOne of the few biotechs with revenue stream. Good pipeline of oncology treatments.210.829.24Health Care
CLH Collection House In similar space as Credit Corp. Strong stock performance has attracted a following and the stock appears to be well placed to run further201.1961.97Industrials
DWS DWS Will be a big beneficiary if governments start spending on IT again.196.5613.09Information Technology
PFL Patties Foods Illiquid stock but has suite of well recognised consumer brands. Defensive yield.193.30-9.3Consumer Staples
RCG RCG Corp The footwear retailer is one of the best performing consumer stocks as online competition is not a big threat. Company has a good yield as well.186.3388.5Consumer Discretionary
IFM Infomedia Interesting tech play in the car parts market. Strong share price gain but gets little air play.176.8765.94Information Technology
NEA Nearmap A stellar performer with an Interesting business that offers high quality aerial maps to companies & government.174.611359.46Information Technology
HSN Hansen Technologies Operates in a high potential/growth industry but is not covered by press or brokers.171.8125.81Information Technology
DTL Data#3 Well respected IT company that receives little press coverage.167.062.03Information Technology
SFH Specialty Fashion Group In early stages of turnaround. Can the women's apparel retailer sustain the momentum?161.4843.31Consumer Discretionary
ESV Eservglobal Mobile money transfer company that has been gaining traction. Widely held by instos but low press coverage160.6381.69Information Technology
CKF Collins Foods One of the few food franchise listed companies.151.5937.36Consumer Discretionary
IMD Imdex Drilling company is well supported by instos and should benefit from any rebound in exploration activity.145.23-44.69Materials
MCP McPherson's The personal care and household products supplier had been relatively insulated from volatile discretionary spend and online threat, but its latest profit warning shows it's not immune.144.66-5.07Consumer Discretionary
BGL BigAir Group The wireless small cap has gained strong following over past year or two but is often overlooked by investors and the press.140.5747.1Telecommunication Services
MLB Melbourne IT A perennial underperformer could be interesting turnaround story as management is in midst of restructuring the business.135.0612.71Information Technology
AZZ Antares Energy Liquid with good insto support. Already in production with exploration upside in Texas.131.32-4.63Energy
SAR Saracen Mineral Holdings Emerging gold producer that is widely held by instos. Hitting milestones and looks cheap. Key asset is close to gold majors, which makes it a potential takeover target.129.47-51.67Materials
AMA AMA Group Good turnaround story but under the automotive services group is radar of most.122.0012.26Consumer Discretionary
GHC Generation Healthcare REITOne of the more interesting REITs. Income is more defensive than typical property stock and its greenfield expansion gives it earnings growth potential.121.8836.64Financials
LCM LogiCamms Strong price performance and reasonable valuation attracting interest.120.6571.06Industrials
POH Phosphagenics Sizable biotech with a game changing FY14 year ahead. Good insto following but questions of poor audit and governance standard could dog company.119.90-18.97Health Care
WDS WDS Widely held with strong insto support. Engineering contractor diversified across mining, energy and infrastructure.115.7948.85Industrials
MNW Mint Wireless Huge market potential if the mobile card payment solutions provider can gain market traction. Management aiming for $1 billion in transaction value a year.113.081547.05Information Technology
REX Regional Express Holdings Well run airline that is overshadowed by Virgin and Qantas.110.09-15.25Industrials
JIN Jumbo Interactive Innovative small cap facing off industry dominated by giants. Worth watching to see if it can carve out a profitable global business.105.0118.61Consumer Discretionary
RUL RungePincockMinarco IT company to resource industry. Facing tough operating climate with new CEO trying to restructure and turnaround company.98.9455.56Industrials
UBI Universal Biosensors IncWell regarded biotech and one of few that's successfully manufacturing in Australia. Struck deal with a few global medical companies.94.38-50.46Health Care
DRM Doray Minerals Widely held by instos. One of the more favoured gold explorers by brokers.90.09-22.56Materials
CAA Capral An aluminium manufacturer that is actually holding up relatively well given that manufacturing is on the nose. 89.92-2.56Materials
BOL Boom Logistics Crane hire group is riding out the downturn in construction.  It's widely held by instos and is very liquid.87.85-30.19Industrials
CLV Clover Corp One of the star performers in 2012. Operates in growing but relatively stable niche.81.76-3Health Care
LGD Legend Corp Electronic parts supplier to utilities and other industries. Stable earnings with good yield. Often overlooked.74.6335.06Information Technology
AOH Altona Mining Noteworthy copper play with Xstrata pull-out of Roseby project in Australia and the good ramp up of its Finnish project.74.51-47.17Materials
EML Emerchants Trying to change way corporates and governments disburse cash with its trackable and controllable debit card offering. If company can get $1 billion in loaded value on cards, the stock will surge.72.31346.15Financials
TAN  Tandou The only direct equity exposure to cotton prices. Also trades water rights and receives little press.68.7216.72Consumer Staples
YTC YTC Resources Next 12-mths will be eventful after YTC secured funding for its projects from Glencore.66.988.7Materials
PEN Peninsula Energy Widely held by instos and large free float. It's the only uranium miner on the list.66.91-52.17Energy
CKL Colorpak The small cap packaging company has grown via acquisitions over past few years.66.8646.88Materials
KOV Korvest The construction products and services supplier has been hit by project delays and deferrals. But its relatively high yield could give it some support.57.746.35Industrials
CUV Clinuvel Pharmaceuticals Interesting skin disorder treatment developer that has done reasonably well over past year55.03-25.39Health Care
GXY Galaxy Resources Good upside potential if it can get its problem-prone Jiangsu plant back on track. Won't be easy to right this ship.53.40-84.27Materials
OTH Onthehouse Holdings Alternative small cap to online property leader REA Group. It is trying to use more timely housing data as a competitive edge against REA.51.77-3.08Consumer Discretionary
TSM ThinkSmart Potential turnaround story worth keeping eye on.50.3255Financials
EBT eBet Potential alternative to star performer Ainsworth Tech. Has exclusive deal with US poker machine maker WMS.43.98194.22Consumer Discretionary
UML Unity Mining Growing Tassie gold producer with high free float. Valuation looks compelling too.40.72-53.6Materials
NTC NetComm Wireless Under appreciated small IT hardware maker that is punching above its weight. Hardly covered by press.27.6786.96Information Technology
PGC Paragon Care Emerging hospital equipment supplier that has been ignored by market.19.83139.82Health Care
Source: Eureka Report, Bloomberg

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