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Stock Analyst Update

Biotech's Earnings Unfazed by a Weak Economy

First-quarter results look solid, but high valuations still plague the sector.

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This was a wait-and-see quarter for the biotechnology companies.

Over the past week and a half, most of the major biotechnology firms reported their first-quarter results. We found that there were a couple of positive surprises, and no real nasty shocks. But for a number of companies, the biggest issues were those that won't be resolved for several months. 

Many of the biotech firms proved that their flagship products--often best-in-class therapies with little significant competition--are still going strong. Perhaps the best showing came from Rituxan, Genentech's (DNA) therapy for non-Hodgkin's lymphoma (NHL) which it co-markets with Idec Pharmaceuticals (IDPH). The drug has repeatedly beaten estimates, but the most recent quarter was especially impressive. Sales grew 25% from the previous quarter and more than 100% from the same period a year ago. The growth was driven in part by more doctors treating a broader range of NHL patients. MedImmune's (MEDI) Synagis and Genzyme General's (GENZ) Renagel also posted nice sales numbers this past quarter. And even Biogen's [ticker BGEN] multiple sclerosis drug Avonex, which has often looked lackluster over the past year, delivered 26% year-over-year growth thanks in large part to heavy marketing efforts.

But many of the companies spent much their conference-call time focused on upcoming events, some of which will be absolutely critical to their futures. Immunex (IMNX), for one, can really only focus on the future, because it cannot adequately meet current demand for its main product, arthritis therapy Enbrel. The company therefore had to cap the number of patients on the drug pending completion of a manufacturing facility in Rhode Island. With the facility not slated to come on line until mid-2002, Immunex could well be in a holding pattern for many months to come.

The other major event that the biotechnology community is awaiting with baited breath is the approval of Xolair, Genentech's new allergy and asthma therapy. Xolair's prospects look pretty good, especially for severe asthma sufferers who often must rely on steroids to keep their ailment under control. However, Xolair must first get past the final hurdle of FDA approval--not an easy task given the current conservative climate at the agency. The drug has a good chance of getting the nod from the FDA, in our opinion, but investors shouldn't be surprised if Genentech's stock suffers from considerable volatility until then. 

Finally, we remain concerned about valuations in the biotech sector. Although many of the stocks are down significantly from their highs, the majority are still trading at incredibly lofty multiples. The industry's forward average P/E (estimates according to Zacks) is nearly twice that of the S&P 500. Moreover, many of the biotech companies' trailing P/Es are well above their five-year historical averages. Companies such as Genentech and MedImmune have shown that they can deliver stellar products, but the recent challenges of other firms like Immunex have shown that such success isn't always a given. Thus, we generally feel that investors should remain cautious on the sector and stick with higher-quality names such as Amgen  (AMGN)--which reports on Thursday--or cheaper, solid names such as Biogen.

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Emily Hall does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.