The biotech sector finally witnessed a rebound in 2017. Since mid-2015, sentiment on the sector had been negative and by early 2016, the NASDAQ Biotechnology Index (^NBI) dropped below the 3,000 mark. A range of factors contributed to this decline, including concerns over valuation, lawmakers’ stance on drug pricing, fewer approvals from FDA in 2016 compared to previous years and lack of M&A activity. While our sentiment on the sector remained bullish throughout the last two years, we believe the correction that began in mid-2015 was much needed. Having said that we also believe that the sentiment remained negative for too long. Indeed, the pricing issue has died down. While M&A activity has not picked up significantly, there were some major acquisitions, most notably, Gilead’s (GILD) foray into the CAR-T space with the acquisition of Kite Pharma. But the big positive for the sector this year has been a rebound in IPOs and follow-on offerings on both sides of the Atlantic and a bounce back in the number of drug approvals.
Image: ^NBI 5 years movement
The NBI is headed for a sharply higher finish for the year (up 22.23% at the time of writing this note) and we are entering 2018 on a much more bullish note. With this in mind here are some stocks that we expect will offer significant upside in 2018. The stock selection criteria were based on upcoming catalysts, current valuation and downside risk.
Synergy Pharmaceuticals: Poised For Recovery Despite Dilution Risk
We covered Synergy Pharmaceuticals (SGYP) extensively this year and continue to like the story even though SGYP is headed for a huge loss this year (down 62.89% at the time of writing). This despite the fact that Trulance, the company’s approved treatment for chronic idiopathic constipation (‘CIC) is seeing a robust uptake. SGYP has been kept down by the high cash burn rate (necessary as the company decided to go alone with commercialization) and recent dilutive offering (we believe it was a poorly constructed deal even though raising funds was necessary).
We must also add that despite $200 million balance on its credit facility and the fact that SGYP is now a revenue-generating company, we see further dilution unless the company strikes a licensing agreement in Europe. Despite all these negatives, SGYP is significantly undervalued in our opinion. And the reason we continue to like SGYP is the simple fact that Trulance is just a better drug than the current standard of care in CIC.
Image: SGYP 5 years price and volume
The big catalyst for SGYP is next month, with the FDA’s PDUFA date for Trulance in IBS-C set for January 24th, 2018. An approval is all but likely. We do not expect any additional costs on the marketing front as the company can utilize the salesforce hired for commercialization in CIC. The recent change of CEO has also been received positively by the market with SGYP promoting its Chief Commercial Officer to the role. More important, the new CEO has already noted that bringing the cash burn rate down is a priority.
Aradigm: 2017 Was Just The Start
After a year that saw gains of more than 250%, Aradigm (ARDM) still makes to our list. Such is the upside potential. The company’s lead product candidate Linhaliq has a PDUFA scheduled for January 26th, 2018. That is the major upcoming catalyst. But there is another one that could play out before the end of this year, or thereabouts. The company’s Linhaliq is up against Bayer’s inhaled ciprofloxacin. Bayer, however, got a CRL and expects a decision on its resubmitted application by the end of this year. At the time of writing this article, there was no update from Bayer on the application. If it is not approved, that’s good for ARDM as it gives it more exclusivity. Even in the case of an approval for Bayer’s formulation and lower market share, we believe ARDM’s Linhaliq has significant potential. In fact, when we modeled for a 50% market share for Linhaliq, assuming approval for Bayer’s formulation, the valuation we got for ARDM still offers substantial upside from current levels.
Image: ARDM 5 years price and volume
Omeros: Too Much Focus On The Pass-Through Status Issue
Omeros (OMER), like ARDM, is also heading into 2018 after a strong performance this year. With gains of 100% this year, OMER has generated substantial returns for a commercialization stage company. Despite the gains, the market is undervaluing OMER as the value of OMS 721 is not priced into the stock at the moment.
Image: OMER 5 years price and volume
We believe that the market is focusing too much on the Omidria Pass-Through status issue. With the expiration of the Pass-Through status, we do expect significant price reduction for Omidria but the key value driver in the long-term is not Omidria but OMS 721, which is being developed in multiple indications. Even assuming a significantly lower price than Alexion’s (ALXN) Soliris, we get promising numbers for OMER. Of the three picks discussed in this article, we believe that OMER offers the most favorable risk/reward profile although in terms of timeframe, this is more a long-term bet. Having said that we do expect 2018 to be another solid year for OMER, considering an important catalyst in September. We also expect some upside once the uncertainty over Omidria pricing will be over soon.
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Disclosure: I am/we are long OMER, SGYP. 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.
Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.