Positioning For 2014 In The Health Care Sector

Includes: DVAX, GILD, NVAX
by: EnhydrisPECorp

As I look out at the health-care landscape, it looks like it will be a particularly busy and exciting year. Mergers and Acquisitions look like they will pick up, small and mid-cap stocks appear to be forming a dreaded bubble, and the Affordable Care Act could place significant pressure on drug pricing, especially on the coveted orphan drug makers.

To make sense of it all, my hope is to pen a six-part series on the matter, laying out our positions in the sector for the year. As a bit of foreshadowing, the series should look something like this:

  1. Health-care picks by market cap (small, mid, large)
  2. Health-care stocks to avoid this year
  3. Health-care picks by drug type (generic, orphan, standard)
  4. Buyout picks
  5. Short picks
  6. Speculative micro/small cap picks.

So without further delay, here are my health-care picks by market cap.

Large Cap Pick

Gilead Sciences (NASDAQ:GILD) is possibly the hottest name among big pharmas these days. Unlike its large cap peers, the company has actually been growing revenues lately. Specifically, Gilead reported that revenues increased by 15% for the nine months ending September 30, 2013, with the bulk of this growth coming from the company's antiviral products. While this is all gravy, I am picking this stock because of the recent approval of Sovaldi, Gilead's potentially revolutionary Hep C treatment.

While first year sales of Sovaldi are only expected to hover around $380 M, peak sales have been projected at close to $4 B. Some analysts have even gone out on a limb by suggesting the drug could become the best-selling drug of all-time with sales topping $13 B annually.

The downside risk for Gilead comes in two forms. First, sales of Sovaldi could underwhelm, although early indicators suggest this won't be the case. And secondly, Gilead is relatively cash poor because of the company's extensive research and development programs, as well as their slate of recent acquisitions. If you recall, Gilead paid $11 B to acquire Sovaldi two years ago, putting a major dent in the company's cash reserves. As a result, shares are currently trading at fifty-four times cash on hand. Ouch!

With that said, Gilead's clinical pipeline is second to none, and they should have yet another oncology drug, idelalisib, approved by the FDA next year. In fact, idelalisib could be a blockbuster in Gilead's stable, giving investors another good reason to like this stock.

To sum up, I like Gilead because its bottom line was increasing prior to Sovaldi's approval, Solvaldi looks like a breakthrough Hep C treatment that will be an absolute megablockbuster, and idelalisib should also be approved this year. Point blank, I wouldn't be surprised if Gilead doubles again in shares price this year.

If you don't own Gilead, my question is, why not?

Mid Cap Pick

Novavax (NASDAQ:NVAX) has been breaking through 52 week highs like a hot knife slicing through warm butter of late. I've owned this stock since the high 2s and only recently took some profits off the table. I am picking this stock because its nanoparticle vaccine platform appears to be flat out game-changing. The company currently has mid-stage trials underway for influenza and respiratory syncytial virus, or RSV, that could churn out megablockbusters. Novavax is also expecting to ramp up their earnings under their BARDA contract this year for pandemic flu, helping to fatten their bottom line and stave off more dilution.

My bet is that if Novavax's vaccines for influenza and RSV continue to show first rate immunological responses, the company gets bought out this year. Most of the major pharmas out there love vaccine makers due to their high margins, and Novavax's platform could be revolutionary.

Perhaps this makes too much sense, but I see a deal with Merck being a good possibility. Merck has a strong vaccine portfolio already, is losing revenues due to blockbusters coming off of patents, and has boatloads of cash to make a deal. Nonetheless, buyouts often come out of left field where no one is looking, so don't hold my feet to the fire on this one. Looking from the outside, however, this would make a lot of sense.

Even if a buyout doesn't go through, I expect Novavax to continue to outperform this year. Positive data readouts and increased revenues should be worth another $2 per share from current levels.

Small Cap Pick

Dynavax Technologies (NASDAQ:DVAX) is a layup in my opinion, and offers investors the best risk-reward ratio in the small-cap arena. First off, Dynavax doesn't have any major catalysts on the horizon. Yes, I said it. The possible European approval-or rejection of heplisav, isn't a big deal. Compared to an approval in the U.S., management has referred to a European approval as the "cherry on top".

In case you haven't been paying attention to this story, heplisav is a Hep B vaccine that was rejected by the FDA early last year over inadequate safety info, but has been shown to superior to currently approved vaccines. Dynavax is thus launching a new late-stage trial that should conclude in 2015, with a potential approval in 2016.

Because of the company's recent cash raise and lack of major negative catalysts on the horizon, I see Dynavax shares slowly rising this year. Of course, if the drug is approved or rejected in Europe, the market may overreact either way.

In the case of a marked rise based on an approval, my advice would be to take some profits off the table. On the other hand, a rejection could provide another buying opportunity. Before all is said and done, I expect Dynavax to reach the $5-$6 range prior to the end of 2015, regardless of what happens in Europe. How can you not like a 50% + annualized rise in share price?

In sum, I've been buying this stock since the low $1's but it rose so quickly that I wasn't able to establish a major position before it hit my cut-off mark (roughly $2). In my view, $2 gives savvy investors a nice moat against overreaction to a rejection in Europe.

Looking ahead, I am a buyer again if the stock shows any weakness going forward. That said, I believe heplisav gets a positive nod in Europe this year, and stock probably goes on to double before the end of the year.

In my next article, I will lay out three stocks that health-care investors might want to take profits on, or avoid altogether in 2014.

Disclosure: I am long DVAX, GILD, NVAX, . I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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