As the government shutdown becomes the longest on record, most offices, including the Food and Drug Administration, are below operating capacity. This, of course, directly affects the health care sector. It has understandably been hampering new drug efforts, leading to the FDA to not accept product applications or user fees for 2019.
Based on a news release from Aimmune, for example, the FDA has halted reviews on all applications submitted after December 21. On January 16th, though, Amgen (AMGN) went through a review with an FDA Advisory Committee and won an approval recommendation. Based on the information available, it seems that the FDA is reviewing drugs that were on the PDUFA calendar if user fees were already paid. The Priority Reviews and Advisory Committees seem to be the priority right now, but we will have more clarity on this if the shutdown continues.
Despite recent news of a vote on the Senate to fund the government for 3 weeks, there is no provision for border wall funding, and President Trump has already indicated he won’t sign it.
Fortunately for investors, during this rocky period, there are both winners and losers in health care stocks. With stocks off to a good start this year generally, the current shutdown appears just a headwind that could be keeping winners at a discount. When the winds die down, we could see quick gains, if we pick the right stocks.
Biogen (BIIB) and Novartis (NVS) - This shutdown has a negative effect on the closing of the Celgene (CELG) and Bristol-Myers Squibb (BMY) merger transaction, which creates a delay for the Celgene drug that treats multiple sclerosis. This drug would be a competitor for Biogen’s MS suite that includes Avonex, Plegridy, Tysabri, which combined for over $6 billion in sales last year. Novartis’ Gilenya is its #1 product in the innovative medicines division that sold nearly $3.2 billion in 2017. So, this delay is a benefit for both companies, protecting some of their biggest drugs from competition for an unknown amount of time. President Trump has previously indicated that the shutdown could last “for years”. Though this is unlikely and probably just bluster, if it does last years it could seriously affect valuations in this way.
The valuations for these two firms are below their five-year average. Novartis has underperformed the S&P 500, while Biogen has outperformed, and Biogen is more favored by the sell-side analysts as compared with Novartis.
Pharmaceutical ETFs with a high concentration of established Big Pharma firms, like the Invesco Dynamic Pharmaceuticals Portfolio ETF (PJP) and the iShares U.S. Pharmaceuticals ETF (IHE) or their constituent holdings (minus medical device stocks, as I’ll talk about below) are probably decent picks here. The logic is that is that big firms benefit from the status quo, and the status quo is frozen as long as the shutdown continues. Any new candidates will be slowed down, but since smaller competitors are also affected, Big Pharma ends up on top here.
Any potential competitor drug to that of an established firm will be delayed, and we’re not just talking about Phase III candidates here. The shutdown, if prolonged, will delay all phases down the pipeline and just increase the amount of time before any competitors reach market. The effects of the delay could last years and won’t go away immediately when the shutdown ends.
Small-cap biotech stocks are mostly losers here. These stocks got hammered during the fourth-quarter sell-off, and have had a recent tailwind which could be seen as mean reversion. What isn't showing up in the returns, though, is that these companies usually do not have multiple drugs in the pipeline, so a slowdown at the FDA can weigh on profitability and increase their financial strain. They are playing against the clock and the clock has stopped, while cash burn must continue. Not a good outcome, and again, the effect won’t suddenly disappear when the shutdown ends. The SPDR Biotech ETF (XBI) contains many small-cap biotechs dependent on the FDA hitting its timetables and could get damaged here.
Medical device companies are also getting the short end of the deal here. The FDA is not reviewing any of these products until after the shutdown is resolved, so these companies will be limited to their existing sales projections, which are probably already priced into their current stock prices. Once funding comes back, the backlog could prohibit these firms from moving faster than expected, therefore forcing them to have less idiosyncratic risk than in the past. Stocks like Edwards Lifesciences (EW) and ABIOMED (ABMD) have had enormous parabolic runs over the last four years, and this shutdown will likely slow them down, which runs the risk of reversing the parabolas downward.
Gilead (GILD) is also at risk here a bit. This company needs to meet with the FDA about its new ulcerative colitis drug, but that will be tough until the shutdown is over.
In conclusion, while this shutdown does play a factor within the approval process, it seems that markets at this point in time do not care so much. Since the markets are not purely black and white, it is in that area that we must play. Outside of favoring larger-cap names, other strategies that could be used are pairing companies to balance out exposure within the industry/sector, going long in one name while shorting an ETF, or to use sizing as an effective measure to lower risk.
Disclosure: I am/we are long NVS. 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.