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Biotech Stocks Losing Strength

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The industry appears ready for a rebound, but increasing costs, intensifying competition, and the possibility of more government intervention could keep key players, such as Amgen, down for the long run.

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You might think biotech stocks such as Amgen (AMGN), Gilead Sciences (GILD), and Biogen (BIIB) are cheap and due for a rebound. After all, as a group, biotech stocks are trading on awfully low price-to-earnings multiples. A glance at the historical trading patterns shows they haven't been down so low since the mid-1990s. Chart watchers, no doubt, will tell you that drug companies are a good bet at these levels.

But please watch out: Biotech stocks aren't what they used to be. There's a good reason they're down so low. They're riskier than ever, and it's getting tougher to see how they can promise the same kind of earnings growth they delivered in days gone by. Higher risks mean that they could stay stuck in a holding pattern for some time.

Take Amgen, which, by most measures, is the premier biotech stock. It hasn't seen a forward P/E so low in the past five years. Indeed, for years Amgen pumped out pretty predictable, steady annual earnings growth of 20% or more. So, trading down at 10 times earnings it looks like a bargain.

But look around. Big changes affecting the drug-development industry make Amgen a much riskier proposition these days. Skyrocketing costs, intensifying competition, and the looming specter of more government intervention mean Amgen shareholders have fewer reasons to feel confident about the company repeating its earnings growth of the past.

For starters, Amgen needs a new growth engine. Its anemia medicines have struggled in recent years amid safety concerns and reimbursement pressures. Two recent drug approvals, Vectibix for colon cancer and NPlate for a rare autoimmune condition known as immune thrombocytopenic purpura, are unlikely to become blockbusters soon. What's more, competition is fiercer than biotech companies have seen before. The days when Amgen and others could launch blockbuster drugs into rival-free markets are long gone.

To get a sense of the competition, consider one of Amgen's most promising opportunities: the market for osteoporosis treatments. It's huge, with more than $7 billion in annual sales, but the competition is downright brutal. Newly approved for use in the US and Europe, Amgen's Prolia is certainly a contender. But GlaxoSmithKline's (GSK) Boniva and Eli Lilly's (LLY) Evista and Forteo are also expected to grab chunks of the market.

The competition doesn't end there. While Prolia will cost about $825 per year, the generic version of Merck's (MRK) osteoporosis treatment Fosamax is now widely available for $100-$200 per year. Across the board, biotech companies are more and more exposed to revenue damage from patent expirations and the rising threat of generics.

Amgen has high hopes for AMG 479, its new monoclonal antibody drug designed to target the IGF-1R receptor associated with pancreatic cancers. Expected to move from phase 2 to phase 3 trials next year, AMG 479 has demonstrated impressive improvements in cancer survival rates. But the thing is, AMG 479 isn't alone in the pancreatic cancer market and development race. Eli Lilly, Pfizer (PFE), and Merck are also making a push.

Then there's the cost of developing a best-selling, blockbuster drug. It's soaring. Scouring the human genome to spot potential treatments, synthesizing a molecular compound, fine-tuning it in the lab, clearing clinical trials and FDA approval hurdles, and then marketing it to doctors and patients now starts at about $1billion dollars. With costs going through the roof, it's tougher for Amgen and its competitors to keep churning out enough new treatments needed to grow sales and earnings at the pace investors have come to expect.

Biotech also has big-business and managed-care companies to contend with. Large corporations are getting together to try to squeeze lower prescription drug prices from the largest drug makers. Managed care companies, big purchasers of pharmaceuticals, have gained enormous clout.

You can't ignore the political risk. More than ever before, drugs are in the political spotlight. Sure, biotech's lobbying power is growing, but at the end of the day US voters want cheaper drugs, which means that state and federal legislators and the president will push for laws that meet these demands but threaten industry profits.

Investing in big-name biotech companies is no longer a surefire way to stock returns. The dependable growth that investors have come to expect from the big-name biotech players is far less dependable. Be wary of those who say that the only way is up for biotech companies. Fundamental industry change, and the risk it creates, suggests that biotech trading multiples could easily stay stuck where they are.

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No positions in stocks mentioned.
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