Getting the best out of biotech

Commodity markets joined in the fun with Brent oil up 7.8 per cent to $64.08 per barrel, its highest since June 2015 and up 136 per cent from last year’s low. The copper price gained 4.4 per cent and zinc, where I now have a greater interest given Central Asia Metals’ (CAML) recent acquisition, was up 4.2 per cent. Copper is at its highest price since April 2014 and zinc at its highest price in six years.

Sterling was down a little against the US$ to 1.3174 and up a little against the euro, to 1.1346. Those who do not think Bitcoin is a bubble but see it as a store of value will be pleased to see it up 55.4 per cent in October, (630 per cent this year) to $7,023. That more traditional store of value, gold, continued to trade sideways, down 0.9 per cent to $1,280 an ounce.

Performance

After a lacklustre September, the UK market had a better month, with the FTSE All-Share (total return) Index up 1.9 per cent. It is now up 9.8 per cent since 1 January and 77.6 per cent since January 2012. The JIC Portfolio just squeaked ahead in October with a gain of 2.0 per cent, and is up 25.4 per cent this year and 166.5 per cent since January 2012. Since January 2012 the annualised return of my portfolio is +18.3 per cent, comparing favourably with the annualised return of 10.3 per cent for the All-Share.

My more focused Top 10 Portfolio, which I mentioned in my August column, was up 4.3 per cent in October and 31.0 per cent since 1 January. It’s doing what it’s supposed to do: achieve a better return than the more diversified larger portfolio. More on that in January when I review both portfolios 2017 performance. 

XLMedia (XLM), one of my largest positions, was the star performer, up 22 per cent, during October on further appreciation of September’s half-year results. There was also some chunky director buying. AdEPT Telecom (ADT), up 12.3 per cent, reacted positively to its trading update, which included a 13.4 per cent dividend increase. Diversified Gas and Oil (DGOC), +12.2 per cent, benefited from the resurgent oil price and published an upbeat trading update at the end of the month. Baillie Gifford Shin Nippon (BGS), although invested in smaller companies, kept up with the rise of the Nikkei 225. It was up 9.0 per cent in October, taking it to +41 per cent this year. Why, oh why, did I reduce my holding last December?

Now the dogs. Accrol’s (ACRL) shares were suspended on 3 October at 132p “while the Board considers the impact on its net debt position and clarification of its financial circumstances”. It has struggled to push through price rises to cover increased input costs, which has resulted in squeezed margins and increased working capital. The conversation with its banks and major shareholders is taking longer than I hoped. I have written down the price to 40p, which I hope is conservative enough. That write-down cost 1.2 per cent from my October performance. If the worst comes to the worst it will cost me another 0.5 per cent from 2017’s performance. Not disastrous in the context of a +25.0 per cent year but a dent to one’s pride. 7digital Group (7DIG) was off 11.8 per cent but more damaging was the 10.5 per cent fall in Bioventix (BVXP). Despite excellent results, which included a 31 per cent increase in revenue, a 37 per cent increase in profits, a 20 per cent increase in the ordinary dividend to 51p as well as a special dividend of 40p, it succumbed to profit taking. Some were worried about its warning that the current year, ending June 2018, could be a flat year. This year it loses the revenue from a legacy product and is uncertain on the speed of the take up of its new high-sensitivity troponin test for heart attacks. I used the fall as an opportunity to increase my position at £23.95 on 19 October, thus benefiting from it going ex its 31p final dividend and 40p special.

Activity

Another very quiet month on the dealing front. Apart from the addition to Bioventix there were no other trades. It was a good month for dividends with £2,096, or roughly 0.5 per cent of the portfolio, going ex.

Meeting the managers

I enjoy meeting companies that I hold or am considering adding to the portfolio. There are many opportunities for private investors to meet management of small- and mid-sized companies at investment forums. The likes of Sharesoc, Equity Development, Hardman and Proactive Investors regularly host forums at which three or four companies present. Often these are videoed and available to private investors at PIWorld.co.uk.

Earlier this month I attended the annual healthcare presentation given by Orbimed, the US-based managers of the Biotech Growth (BIOG) and Worldwide Health Care Trust (WWH). First, it reminded me that selling my holding in Worldwide Healthcare in December wasn’t the cleverest thing I have ever done. Since then it is up 25 per cent, although to be fair my portfolio has kept up with that.

Orbimed’s Sven Borho gave a compelling presentation on why the biotech sector should perform well over the coming year. The main strands of the argument were: many of last year’s concerns about political interference had subsided; it had been a strong year of scientific progress; the US Food & Drug Administration (FDA) had speeded up its approval of new drugs; M&A activity was expected to pick up and, once again, positive clinical data and FDA approvals were having a dramatic impact on share prices. Above all, he pointed to the attractive valuation of big biotech, both in absolute and relative terms.

Taking each in turn: On the political front, drug pricing had not really been an issue and Obamacare had failed to be repealed. In fact, the rhetoric was moving towards positive factors for the sector such as tax reform and the repatriation of offshore cash.

Scientific progress had seen many novel platforms reaching commercial stage. Gene therapy, gene silencing, CAR-T and protein correctors are now producing real results in diseases that were previously poorly served. An example sited was ex-President Jimmy Carter’s cure of metastatic cancer, thanks in part to a groundbreaking new kind of medication that trains the immune system to fight cancer tumours.

Scott Gottlieb’s appointment as head of the FDA was described as Trump’s single best decision. He has transformed the approval process and Orbimed believes that 2017 will beat the previous record, (45 in 2015), for new drug approvals, with a flurry of announcements over the next couple of months. The approval of AstraZeneca’s Calquence on 31 October was a recent example. It was not expected until early next year. Calquence is indicated for the treatment of adult patients with mantle cell lymphoma who have received at least one prior therapy and results show “40 per cent of patients achieving a complete response”.

It had not been as strong a year on the M&A front as Orbimed had expected but it believes it is just a case of it being delayed rather than abandoned. Once tax changes are passed, which it had expected by the end of April, it believes non-US-cash balances, once repatriated, will be deployed by big pharma to buy biotech companies with innovative research.

Mr Borho pointed to the cheap valuation of large-cap biotechs (stocks such as Gilead (US:GILD), Amgen (US:AMGN), Celgene (US:CELG), Biogen (US:BIIB) and Idec (JP:6652)). This group of stocks is currently valued on a forward price-earnings ratio of around 12.5 times compared with 17.5 times for the S&P 500. We were invited to ponder whether Celgene would remain on a 2020 PE ratio of 7.8 times for compound earnings growth of 19.9 per cent between 2017 and 2020.

Finally, Mr Borho pointed to plenty of near-term catalysts in the Biotech Growth Trust portfolio.

I added the Biotech Growth Trust to the JIC Portfolio in early 2012 as I was excited by the prospects of a golden age of drug discovery, driven by huge technological gains – eg, our improved understanding of the human genome. The boost to the efficiency of research from the tremendous increase in computing power was another powerful factor. Many private investors say they won’t touch biotech as they don’t understand it. I agree, that as a layman, picking individual stocks in this area is like entering a casino. But if you buy into the general theme, why not let the experts build a portfolio for you? Since my first purchase in April 2012 the share price has risen 3.6 times and I think it has a lot further to go over the next five years.

Looking ahead

The 30th anniversary of Black Monday on 19 October passed without incident. Traditionally, the summer months, from 1 May to 30 September, have been quieter for equity markets than the winter seven months. 

Over time there is good evidence that being invested during the winter period and then going to cash during the summer five months has given significantly better returns than being invested all through the year. For example, since January 1986 the FTSE 100, excluding dividends, has recorded a negative return between 1 May and 30 September more than half the time. Over the same 30 years, during the summer five months the FTSE All-Share Index fell 31.8 per cent, for an average loss of 1.1 per cent. 

During the winter seven it rose 211 per cent in total. In the last year, the FTSE All-Share (TR) Index gained 7.7 per cent between 1 October 2016 and 30 April 2017 and 4.0 between 1 May and 30 September. So, not a bad summer and a good start in October, to the winter period. Of course, none of this tells us where we are going in the next six months and the siren voices calling for a correction are getting louder. For the time being, I am going to stick with the adage that the trend is your friend, (until it isn’t) and remain fully invested.