[This was written Friday but the site was down and I was unable to post it. I am publishing it as it was Friday and will write another column later today for more recent news]
Well, it was a manic day with a very nice win followed by the broader morning bloodbath in the sector. I will take these in turn in terms of why it happened and what to expect going forward.
1. The sector was hit hard this morning and the proximate cause seems to the letter from Congress to GILD about the pricing of Sovaldi. If you remember, early in the year I talked about concerns over drug pricing as being a potential catalysts to burst the bio bull market. I think days like today show you why that is the case. Congress has done nothing and insurance companies are on pace to reimburse over $7B (if not more) in Solvaldi sales but just the hint that pricing may be in jeopardy is enough to send GILD much lower and bring the sector down with it. While this is mainly just a GILD issue, this has wider implications given the role that drug pricing plays into the profitability of the sector. This explains the moves in CELG, ALXN, and others in sympathy to GILD.
2. So where does the sector go from here? In the short run there still might be downside and if this pricing concern persists, we could still be going lower over the medium term. That being said, the large cap names have a lot of levers in their favor. First, this sell off is taking a lot of bubble valuation fears off of the table. Of course, if they are forced to cut prices, then valuations could go lower. My point being here is that we are getting closer to the DCF fair values, which represent long term value. So we may very well be getting to the point where genuine buying interest picks up. Second, these companies are cash rich, so they have the option to accelerate or increase buybacks or other shareholder friendly actions. If the selling continues, I think the pressure to return cash to shareholders dramatically increases (if it has not done so already). So does this ultimately mean to buy, buy, buy this dip? Not necessarily. As I have said before, I will not be able to pick the bottom and I think we have the potential for more downside. My plan is to continually nibble on these sell offs and at some point the sentiment worm will turn and the bull run will continue.
3. The better news of the day was the positive recommendation from CHMP and the positive NSCLC data. These were both going to be close calls (particularly the CHMP decision) and that is why you see the big move in response to the positive catalysts. We still have one major catalyst for the year and that is the phase III PROC data, which is expected by mid-year. Keep in mind that if that fails the PFS interim look then the CHMP recommendation is meaningless as it needs the phase III to confirm the phase II results but that seems like an unlikely event. I suspect that ECYT consolidates into a range if not drifts lower after this news. For reference, RBC (before the news) did a scenario analysis and said that positive NSCLC data and positive CHMP recommendation puts the price target at $31. Given how quick ECYT got there, it is likely that they will raise that target (and others will too) but that is a good reference point for where ECYT “should” be at this point. I would be tempted to add below $25 and certainly if it gets into the lower $20s.
4. So where does the ECYT bear thesis go from here? I think they hang their hat on the NSCLC data with p-value being one tailed and the threshold of 0.1. A more conservative approach would have been to use 0.05 and a two-tailed test. Keep in mind, however, that this is a phase II study and was meant to determine if there is a strong enough trend to push this through to phase III. In other words, those goalposts were not necessarily meant to prove efficacy but to give enough of a signal to justify the phase III investment. I think it certainly clears that hurdle but I suspect the bears will talk down this data for the threshold. It is legitimate to argue that these results are good but not proof of efficacy (and I agree with that) but be careful of those trying to use this data for what it is not meant to be used.
5. I will end with some quick comments on EPZM. From a fundamental perspective nothing much has changed and the selling is most likely related to the broader market weakness. We will still get updates from the ongoing trials this year but unlike ECYT, we do not know exactly when so it is more at the whims of the sector until the data. That being said despite have lower lows, the RSI is not confirming with lower low, which makes me think that the selling is running out of steam. I suspect this stock will be quite and then move fast when data comes out (like it did in November and then January). Long story short, I think this move has been technical in nature and that the fundamental story remains intact.
I will call it a week and hope that everyone has a great weekend.
Disclosure: Long EPZM, ECYT, GILD, and CELG.
