Bret Jensen September 22, 2014 Comments Off

Small biotech and pharma stocks have not yet fully recovered from their deep sell-off in early March. Bret Jensen is using the negative sentiment that drove these stocks down earlier this year to selectively add shares before a potential turnaround. 

Small biotech and pharma stocks have not yet fully recovered from their deep sell-off triggered in early March when investors fled “risk on” sectors in the market. Most equities in these sectors are still down substantially from earlier this year even as large biotechs like Gilead Sciences (Nasdaq: GILD) have fully recovered from their pull backs and have bounded much higher.

Other than a couple of small biotech firms that were bought out by larger players only two small cap biotech stocks come to mind that are higher now than they were then. One is Achillion Pharmaceuticals (Nasdaq: ACHN). a hepatitis C play than is benefiting from Gilead’s blowout sales numbers for its hepatitis C drug Sovaldi and some encouraging but very early phase trial results.

The other is Avanir Pharmaceuticals (Nasdaq: AVNR) which just announced very positive results for its compound to treat agitation in Alzheimer’s patients. The shares have more than doubled (as of this writing up 106% in less than 3 months ) since being one of the first selections within the portfolio of Small Cap Gems monthly.

Being a contrarian investor I have started to add a few shares to some of core selections within my speculative biotech portfolio as the negative sentiment on this area will improve and the stocks within will head higher.

Let’s start with the stock of Xoma Corporation (Nasdaq: XOMA) which sold off sharply in the March pullback but has behaved better recently. Even with some recent strength the shares are selling at half what they were going for before the March biotech debacle. However, the investment thesis for owning the shares has changed little and the stock remains a high risk/high reward play.

Xoma focuses on antibody research and has built a portfolio of innovative therapeutic antibodies, both in late-stage clinical development and in preclinical research. Its lead product is gevokizumab which is a beta modulating antibody that is in Phase II and Phase III trials for several indications. Results of a phase III trial using gevokizumab as a treatment of Buhcets Disease should be out within months if not sooner.

The results from this trial will be the primary catalyst for the stock – positive or negative – in the short term. If the trial succeeds, the stock will soar. If it does not the company might have to do a dilutive capital raise to fund its other trials. Analysts are generally positive on Xoma’s prospects with the seven analysts covering the stock having current price targets ranging from $7 to $14 a share on Xoma which currently is priced at $4.50 a share.

I took an initial stake in Prothena Corporation (Nasdaq: PRTA). a small biotech with a market capitalization of just less than $650 million, this week. The stock goes for $23.50 a share about half what it was going for before the recent sell-off in the small biotech sector. The company has several early stage compounds focused on developing novel antibodies for diseases involving protein misfolding or cell adhesion such as Parkinsons which it has a partnership with Roche to develop.

Prothena actually was spun off from the much bigger Elan in late 2012 and came with a seasoned management team that has experience successfully bringing drugs to market. The company also has over $300 million in net cash on the balance sheet. This equates to half the company’s market capitalization and alleviates any need for Prothena to raise any funds to get its early stage drugs through trials – hopefully successfully.

Wedbush initiated the shares as a Buy this week and placed a $46 a share price target on Prothena. The four analysts that cover the shares have a median price target of $45 a share on the stock. It will be a couple of years before any of the company’s compounds make it through it all the way through phase trials to approval. However, given the company’s numerous promising compounds and its domicile in Ireland, it would hardly be surprising if a mid-tier player in the space makes an acquisition bid as that could enable a “tax inversion” that is so popular in the sector right now.

Finally I added a few shares in Fibrocell Science (Nasdaq: FCSC) this week. Fibrocell is an autologous cell therapy company focused on developing first-in-class treatments for rare and serious skin and connective tissue diseases with high unmet medical needs. The stock has been a disappointment since I picked up my original stake in mid-June but I still like the prospects for this speculative play and I also think the shares could get a boost as the company hosts its annual R&D day on Wednesday.

Like Prothena, Fibrocell has a huge slug of net cash on the books which amounts to some 40% of its overall market capitalization of some $120 million. Also like Prothena the company has several compounds in early stage development.

Insiders have a huge stake in the firm and have been frequent buyers of additional shares throughout 2014. Given its small size, only two analysts cover the stock currently. One has a $7 a share price target on Fibrocell and the other analyst is at $9.25 a share. The stock currently trades at just under $3 a share but sold near $6 a share before the risk on selloff in March.

I want to end this piece with my usual caveat. Investing in small biotech and pharma firms is fundamentally different than investing in other sectors. Some hedge funds employ PhDs in biochemistry but still get it wrong as much as they get it right. How drugs and drug compounds perform in actual trials is next to impossible to predict consistently. Anyone who says differently is selling something.

The sector calls for a different investing strategy. My philosophy is to take much smaller positions in a larger amount of selections than in other sectors. I have dubbed this strategy “Shotgun Investing”. You must realize that there will be many misses within the biotech and pharma portion of your portfolio. However, this should be compensated for by the occasional five or ten bagger.

Avanir at +106% in 3 months is just example of the kinds of winners were adding to the Small Cap Gems portfolio. Discover how were adding the next Avanir and how you can get it in before the next run up. CLICK HERE .