BIOTECH: A SHELTER FROM THE STORM?

In what may be the worst stock market crash of our lifetime, biotech stocks are holding up surprisingly well. This may seem counterintuitive, as biotech has traditionally been regarded as a risky sector, for bold investors only. Is this relative safety a new paradigm, or just a fluke? Are biotech investors “in the clear?” or is the worst yet to come?

Truth be told, stock market crashes and financial panics are interesting. Unfortunately these incidents are interesting much the same way that a car crash is interesting. Equal parts revolting, terrifying and interesting. Mostly interesting as long as you are not the one locked in the car that is being crushed to pieces. Each crash scene has a crime scene investigator. This detective arrives on the scene for two reasons. Yes, her job is to figure out what went wrong, and assign blame if appropriate. But, more importantly, she seeks to collect data to share with the public, so that similar accidents can be avoided, or reduced, in the future. Let’s investigate with an eye towards preventing future carnage.

One surprising element of our current national catastrophe is that biotech stocks remain relatively unscathed from the worst of the financial trauma. As of the writing of this post, the $SPY exchange traded fund, which represents the biggest, most blue chip, most established names in American Business, is down 22.9%.  While the $XBI, which represents a basket of biotech stocks, both large and small, is only down 17.6%.  Now nobody likes to lose 17%, but that kind of drop would only register as a blip for most seasoned biotech investors, who are used to huge price swings and constant volatility.

How could a basket of risky, often unprofitable, companies possibly be looking more stable than the largest behemoths of corporate America?

Is this sustainable?

The answer comes down to the following question, “What makes a good business in troubled times?”   Ironically, some of the hallmark characteristics of biotech actually look quite promising during economic uncertainty. Let’s explore.

Will Demand Hold Up Under Pressure?

“Under Pressure” isn’t just a catchy tune by 70’s rock legend Queen. “Under Pressure” is the new lifestyle for the American corporate executive. All kinds of people who previously thought their business addressed a very steady market are finding their customers evaporate overnight. Some of this pain is very particular to the Covid-19 crises (death cruises and empty hotels come to mind). Other shriveling markets are just due to the psychology of fear that takes hold during an economic free fall. Even when people can go back to the mall (whenever that will be) they may be scared to spend money on consumer luxuries. A good deal may never go back to the mall again, now that they have grown comfortable shopping from home.

So, the S&P 500 is forced to endure a double whammy. The decimation of demand for entertainment experiences, and some very shaky long term prospects for consumer luxuries, both large and small (no new cars for a while, certainly no expensive clothes or jewels).

Health and survival, on the other hand, clearly remain paramount for the majority of Americans, and evidently most of the world. We have gone to extreme lengths (potentially destroying our own economy) in order to preserve health. Along the way, the Media has emphasized themes such as rapid innovation, “outside the box” thinking, and perseverance in the face of great challenges. All of these elements dovetail nicely with the biotech process, the biotech ethos, and hopefully, life saving outcomes.

Clearly Americans are willing to give up a great deal to remain healthy.

Can The Customers Pay?

A very large number of formerly rock solid businesses are going through crisis not because clients don’t want to pay, but simply because clients can’t pay. Very few shopkeepers or homeowners default on their mortgage because they want to be evicted. A major cash flow crisis has decimated millions of Americans’ ability to pay even for critical services.

Who have we turned to during these times of panic?  Uncle Sam. As of the writing of this post, congress approved a 2 trillion dollar rescue package, an unprecedented government intervention in American history.

For years and years, the biotech sector suffered due to the perception that the business was too dependent on the government. Too dependent on approval from government bureaucrats, too dependent on legislators that might abolish the current healthcare system, too dependent on Medicare and Medicaid agencies that might pay high prices for drugs, or might not.

Suddenly, like a lightning bolt out of the blue, biotech’s largest liability is it’s strongest asset!  Suddenly, Uncle Sam is seen as the only large player who can reliably pay his bills. In this light, businesses that depend on government payers are like lifeboats on the Titanic; rare, sought after, and not enough to go around for everybody.

The current crisis also seems to neutralize the largest single boogeyman for biotech stock prices: the threat of radical health reform. If we have learned one thing over the last decade of constant partisan battle over Obamacare, it is that health reform is a demanding work out for politicians, with high political risks and costs all the way around.  Right now, almost every governmental participant, on each side of the political aisle, has her hands full with pressing issues of day to day survival. Radical healthcare reform will have to wait for another day. Another day long into the future. This is very good for biotech.

The last reason why biotech can look forward to some very willing and able clients is a sea change in attitude that is being forced by the current crisis. Instead of constantly attacking “greedy” pharmaceutical companies for high prices, the Media has taken to constantly praising brash pharma innovators as “our best hope.”  For years and years, pharmaceutical execs were cast as the “bad guy” by a Media constantly looking to assign blame. Now, suddenly, pharma executives are knights in shining armour.

Even the attitude towards payment itself may change radically. One part of the biotech controversy was the fairness of high prices. But another part of the debate was simple affordability. The Media never tired of trotting out dire statistics about how soaring medical costs were about to bankrupt America.

As of March, 2020, we are about to find out, once and for all, if Uncle Sam can ever go bankrupt. Most the multi-trillion dollar rescue package approved by congress will be fantasy money that the Fed creates out of thin air. We are about to print trillions of dollars without even bothering with the actual printing process. If this harrowing experiment is successful at all, questions of affordability will be settled. Many biotech outfits will serve a market where the single biggest client has an unlimited bank account. Doesn’t that sound like a good market?

Can The Product Be Delivered?

If you have willing clients who can pay your price, then the last relevant question is: can you produce the goods or service?  The way the current crisis has unfolded, the vulnerability of our highly globalized supply chain has been laid bare. If workers in China are sick, they can’t make your product for import to the USA. Even once those Chinese workers get better, our delicate web of international logistics has been shredded by a viral chain reaction.  Companies that make cleaning and sanitizing products should be earning a fortune right now. But many are not. Just because they have someone willing to pay for the product does not mean they can actually make the product.

Biotech, as a sector, has a lot less of this particular problem.  Altogether, many biotech medicines are not even made by people, they are made by genetically altered bacteria!  While some pharmaceutical production has been hindered by a lack of basic materials being imported from China, this problem mostly applies to manufacturers of low value, generic drugs. Most biotech companies listed in the $XBI fall into one of three buckets.

First, many publicly listed biotech companies don’t even have an approved pharmaceutical in production yet. They generate value for shareholders through the advancement of intellectual property and patents. There are no components or materials to physically move, so value cannot be destroyed by logistical shocks.

Second, for many biotechs that do manufacture and market drugs, the manufacturing process is simple. What was tough was pioneering the intellectual property that makes the pharmaceutical possible. Thus, minimal problems are caused by a wounded logistics chain.

Lastly, for some biotech concerns, the manufacturing process is very complicated, costly, and demanding. So demanding, in fact, that they never were able to outsource manufacturing to China. Many biotech products are created using special bacteria, or highly proprietary processes that no executive ever would have wanted to send to China. For these businesses, almost nothing has changed despite a crisis that has shaken the world’s economic foundations.

Tactics & Strategies

After analyzing the factors discussed above, we realize that we could be entering a golden era for biotech investors. That being said, not all biotechs are created equal. Those that do not have strong capital reserves or strong financial backers could wind up being blown away in the hurricane. Below are some ideas to weather the storm.

• If you don’t have time or confidence to do the research, stick with exchange traded funds. $XBI, $IBB, $FBT should give you robust and broad exposure to the sector.
• Favor names doing essential research for broad diseases. The trend over the last few years has been to focus on rare diseases. That trend may now be reversed. When money is tight, or Society has entered crisis mode, the greatest good for the greatest number of people becomes the imperative. Focus on research that saves highly visible lives. Some ideas could be $MRNA, $AMGN, $CELG, $BIIB
• We may be entering an era of renewed focus on infectious disease. These names were out of vogue for the longest time. Curing and preventing infectious disease may suddenly seem much higher priority for the Powers that Be. Some ideas could be: $ADMA, $VIR, $INO
• Focus on biotechs with strong funding in place. It may be all but impossible to raise fresh funds over the next 24 months. As they say, “cash is king.” Biotechs with strong cash reserves are: $GILD, $CRSP, $VRTX

Smooth seas never made a good sailor. But choosing a sturdy craft to start may be a wise move. Biotech may well be just the vessel you need to ride out this stock market storm.

DISCLOSURE:  The Sick Economist owns $GILD, $ADMA and $MRNA