By Lauren R. Rublin

Investors have circled back to healthcare stocks this year, and they're likely to stick around. If they came for the science -- blockbuster obesity drugs, advances in cancer treatments, novel cell therapies -- they'll stay for the macro story, specifically a slowing economy and falling interest rates, which tend to favor the sector. "We are in a wonderful, magical moment in science -- and investing," says Eli Casdin, chief investment officer and founder of Casdin Capital, and a member of Barron's 2024 Healthcare Roundtable.

The sector's lackluster performance in 2022 and '23, and a brutal bear market in biotech, have left the shares of many pharmaceutical, biotech, and life-sciences companies alarmingly -- and alluringly -- cheap. At the same time, advances in diagnostics, drug development, and delivery are turning some once-fatal diseases into chronic conditions and offering fresh hope to millions of patients and their clinicians.

While the regulatory environment is cause for some concern, due in part to the introduction of Medicare drug-price negotiations, regulators are likely to look less skeptically on mergers and acquisitions in the next administration, no matter the party in power. Plus, lower interest rates will make financing more affordable, especially for young companies that desperately need funding.

This year's Roundtable was held on Sept. 12 on Zoom, and featured four healthcare investment experts: Andy Acker, portfolio manager of the healthcare and biotech strategies at Janus Henderson Investors; Casdin, a veteran biotech investor; Daina Graybosch, a senior managing director and biopharma analyst at Leerink Partners; and Jared Holz, healthcare equity strategist at Mizuho. In addition to sharing their big-picture views, our panelists made the case for 21 healthcare companies of all stripes, and their shares.

An edited version of the roundtable discussion follows.

Barron's : Healthcare stocks are on the rise after several years of poor performance. What is drawing investors back to the sector, and more important, what is the outlook?

Andy Acker: Despite expectations for a recession back in 2022, the economy has stayed stronger for longer. That hurt the healthcare sector, which is viewed as more defensive. Also, the industry has suffered a Covid-19 hangover. Sales growth accelerated during the pandemic due to demand for new therapeutics, vaccines, treatments, and diagnostics, but that sales burst has come off in the past couple of years.

Recently, however, the economy has shown signs of starting to slow. Interest rates are expected to come down, potentially this month. [The Federal Reserve cut interest rates by half a percentage point on Sept. 18.] Lower rates could be a boon to the sector, and especially biotech companies, which have long-duration assets and in many cases are years away from meaningful revenue and cash flow.

Eli Casdin: Rising interest rates in 2022 and '23 really squeezed small companies. Cost-of-capital anxiety has made biotech a difficult place to invest. With the loosening of that interest-rate belt, biotech companies potentially will have an easier time getting funding. And there are some strong data indicating that biotech has worked well in recessions.

Many companies have no earnings to revise downward. The industry isn't cyclical in the typical sense. As people become more comfortable with inflation falling and monetary policy loosening, biotech stocks could pick up again.

Jared Holz: The healthcare sector is dominated by two categories -- large-cap pharma and managed care. Both are facing political and regulatory crosscurrents, and both need to outperform to create a successful trajectory for the broader healthcare space. I am skeptical that healthcare will outperform in the near term unless both of those categories do well concurrently.

As for biotech, the stocks haven't done anything on a net basis in more than a decade. This has been a flat sector, with the exception of the pandemic. Unfortunately, a lot of investors looking at the space have been tricked into thinking that either innovation, drug approvals, or mergers and acquisitions would lead to better overall performance. Empirically, none of those are drivers for better performance. Unfortunately, if you're an investor in biotech, you have to cross your fingers that macro trends, whether lower rates or something else, will help you make money.

You might get some pushback on that idea from this panel, but first, let's hear from Daina.

Daina Graybosch: The Inflation Reduction Act was passed just as the Covid pandemic was ebbing, and it sparked a lot of nervousness about drug price trends -- namely, how to think about the tail [revenue in the later years of patent protection] of some important products. We have now had the first round of Medicare drug-price negotiation as mandated by the IRA, and it perhaps wasn't as severe as people feared. That could be positive for some of the larger drug stocks.

While the environment for biotech might be challenging overall, individual companies could have opportunities, and the science keeps investors engaged. I see opportunities in companies that have good fundamental data and have been de-risking.

Acker: I agree with Daina. We should remember that we are investing in the least-efficient sector of the market. Every year for the past 10 years, the difference between the winners and losers in the healthcare sector has been more than 300%. In biotech, the divergence has been even more extreme. The healthcare sector, more than any other, lends itself to active management. Owning the right stocks and avoiding the worst ones can add tremendous value.

Moderna recently reduced its research-and-development spending and said it was pausing development of certain products. Will an announcement like that weigh on sentiment across the pharma industry?

Casdin: The company's lead mRNA franchise doesn't have the same growth dynamic as in the past. Moderna needs to focus. For investors, Moderna probably is more interesting, not less interesting, as a result of this decision. Periods of contraction are painful for investors' wallets, but healthy for the industry. Companies that come through the rationalization process are better businesses and, therefore, better investments.

Speaking of better investments, GLP-1 obesity treatments are the talk of the healthcare market. The shortage in Eli Lilly's GLP-1 treatments seems to be ending. Sales of Novo Nordisk's Ozempic and Wegovy are climbing sharply, and additional data have come out about other indications for the drugs. Have your expectations about the size of the market for these products changed?

Acker: We have owned Eli Lilly and Novo Nordisk for the past 10 years in our healthcare strategy. Did we know GLP-1s would be this big? No. These products started as diabetes drugs. We are now recognizing that they are highly effective as treatments for obesity, which may be the biggest market opportunity we have ever seen in healthcare.

More than 100 million people in the U.S., and 800 million globally, are overweight or obese. As of this year's second quarter, the obesity treatment market was dominated by two companies, Lilly and Novo, and their stock performance reflects that. On an annualized basis, GLP-1 sales are more than $50 billion, and still growing by 50% a year. Global penetration is still in the low-single digits.

Lilly and Novo have competitive advantages. Manufacturing these products is extremely difficult and expensive. A plant costs more than $1.7 billion to build, and requires three to four years of lead time. There are a limited number of manufacturers of the equipment needed to build these plants. Lilly and Novo are spending, combined, about $10 billion this year in capital expenditure. It will be difficult even for makers of biosimilar treatments to compete as Lilly and Novo's patents expire. There will be some competition, including companies we are invested in and excited about, but the competition is still a few years out.

Holz: This is the most complex sector in the market, and the easiest concept to understand. Obesity will remain No. 1, or close to No. 1, as a category of interest for the buy- and sell-side going into next year. So, many therapeutics are given to patients too late. We're finally seeing a drug that is a preventative medicine for a whole host of underlying conditions. That is an underappreciated element of the bullish thesis.

Eli, are there particular biotech companies that you regard as potential longer-term competitors to Lilly and Novo, or that could be compelling takeover targets for Big Pharma in the GLP-1 space?

Casdin: While technological leadership seems to favor Lilly and Novo, what is the margin of their leadership as competitors enter this space? It seems the threat is pricing pressure from competition more than market-share grabs. The small-molecule element of this market is competitive globally. Lilly is in the lead with Phase 3 data coming next year for its small molecule, and that data will help establish the potential for oral agents in the obesity market broadly.

We have been longtime shareholders in Structure Therapeutics, first investing in 2021 when it was still private. Structure is next in line, with a first-generation pill form of GLP-1 and a pipeline of next-generation oral solutions. We think Structure is a prime partner for any pharma that wants to build a leading franchise in this space.

Daina, could the high prices of GLP-1 medicines affect the conversation around drug pricing, spurring a new effort at drug-price reform beyond the IRA?

Graybosch: Yes. Some states have said that the cost of these medications is having an impact on their overall budget. The cost of insulin has been at the center of conversations about drug-price negotiation. The cost of GLP-1s could have a bigger and broader impact. It will be part of the discussion in the next administration, no matter who is in charge.

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September 27, 2024 15:24 ET (19:24 GMT)

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