4 Biotech Stocks Outperforming Vertex

| About: Vertex Pharmaceuticals (VRTX)

Since the beginning of 2012, the Nasdaq Biotechnology Index has increased 30% despite taking a huge dip near the conclusion of Q1. Vertex Pharmaceuticals (VRTX), makers of Incivek (telaprevir), received a noticeable boost in the biotechnology market as recently as last month. After releasing the positive results of a study that tested the efficacy of Vertex's newest hepatitis C medication, Vertex had positioned itself firmly ahead of its peers. Unfortunately for Vertex shareholders, Abbott Laboratories (ABT) published the findings of a study of its own drugs in April 2012, which researched the efficacy of another highly effective hepatitis C drug. In my opinion, these studies prove that Abbott has potentially created drugs that are far superior to Incivek.

Early this year, I took note of Vertex, making a fairly large news splash with the results of its latest study. Vertex seemed to have positioned itself as a major player in the biotechnology industry's hepatitis C sector. Phase II trials of Vertex's newest drug appears to have an overall efficacy of 74% of untreated hepatitis C patients when combined with Incivek. Poised to build upon the growing hype, investors began to take a long look at Vertex's potential over the near term. According to the research firm Decision Resources, the biotechnology industry as a whole is set to reach the $16 billion level by 2015.

In my opinion, the proverbial writing is on the wall, and Vertex seems positioned to take a precipitous fall as Abbott's far more effective medications begin to propagate on the open market. I also believe strongly that the timing of Abbott's study is too convenient to be strictly coincidental. To be fair, the medications in question are merely in the mid-clinical trial stages, and there is much research to be completed before these new drugs are available to the public. Either way, Abbott's superior investigative drug has spooked potential Vertex investors to the bone.

Vertex by the Numbers

With a market cap exceeding $8.2 billion, Vertex has definitely carved out a space for itself in the biotechnology field. From the standpoint of trading volume, 2.9 million shares traded over the last three months shows that the company has plenty of suitors. Personally, my optimism for Vertex ends when discussing the drugmaker's margins and earnings multiples.

Even Vertex's cash flow is less-than-impressive by any standard. Vertex only has $143 million in operating cash, and it also has an inverted levered cash flow of -$22 million. Vertex's forward price-to-earnings ratio of 12 is reasonable in my opinion, but the company's gargantuan trailing price-to-earnings ratio of 286 suggests that bullish investors missed a big opportunity last fiscal year. From a marginal perspective, Vertex's anemic 2% profit margin is cause for concern. The gap between trailing and forward earnings multiples is simply too vast to make me into a believer of Vertex's future in the hepatitis C niche, too.

Four Competitors in a Better Position than Vertex

Abbott has spoiled the proverbial apple cart for the entire hepatitis C sector. Over the span of a single month, Vertex has fallen from grace, from industry trend-setter to old news in a matter of weeks. I see the Vertex-Abbott issue at hand as proof of how volatile the biotechnology field can turn amid a stagnant global economy.

Abbott has created not one but two hepatitis C drugs that display an efficacy well over 90% in previously untreated patients. As mentioned previously, Vertex's new drug has only a 74% efficacy, which to be fair is impressive in its own right. Abbott's market cap has soared to over $96 billion while the company's forward price-to-earnings ratio of 11.5 remains realistic, even considering the recent good news of Abbott's incredibly effective new drugs. I strongly believe that Abbott is both a superior company and long-term investment, particularly with $8.9 billion in operating cash available over the near term.

Vertex's relationship with industry mega-giant Johnson & Johnson (JNJ) is further cause for pessimism when comparing Vertex to its primary competitors. In fact, Johnson & Johnson markets Incivek overseas by the name Incivo, and it is not unheard of for cozy relationships to develop among biotechnology players. From my perspective, Vertex appears ripe for a takeover by Johnson & Johnson, but in all fairness, the two companies have not discussed this possibility publicly. Compared to Vertex's disparate forward to trailing earnings multiples, Johnson & Johnson's stable forward price-to-earnings ratio trumps Vertex well.

Bristol-Myers Squibb (BMY) and Gilead Sciences (GILD) have both made acquisitions that give me pause when considering Vertex as a solid wager. Earlier this year, Bristol-Myers purchased Inhibitex with the purpose of expanding the company's portfolio of hepatitis C medications. Gilead acquired Pharmasett in the fall of 2011 for the same purpose: the take the lead in the hepatitis C/HIV niche market. Before Abbott published its findings, Gilead had placed itself in prime position to secure a foothold in this emerging market. Gilead's 33% profit margin proves that the company is heading the right direction compared to Vertex. Of course, the same logic applies to Bristol-Myers which like Johnson & Johnson has a reasonably stable earnings multiple of around 16.

At the end of the day, Vertex was upstaged by Abbott at the start of Q2 2012, and in my opinion, the timing of Abbott's publication is too profound to be an accident. Vertex is far from dead, however, but its future in the budding hepatitis C market is questionable at best.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

About this article:

Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500.
Tagged: , , , Drug Manufacturers - Other
Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here