Consider Protection for Biotech Portfolio

The Big Picture: How to Protect your Biotech Portfolio

We are not turning bearish on biotech at this point. But we do think it’s a good time to be patient and to consider some portfolio protection.  

Biotech investors were reminded that the sector is inherently volatile last week. The Nasdaq Biotech Index (NBI) was up over 33% in 2015 as of July 17. But it gave back 5% on the week that ended July 24th, which is a pretty good haircut. Still, barring some further evil developing, we are expecting that NBI could head to 4500 as long as it holds above 3900. But the 3900 support level for NBI is now our benchmark for the current advance.   A sustained break below this key price area would be very negative.
BIS biotech index 2015 07 24NBI biotech index 2015 07 24

In our July 17 update we noted: “While we are not making a market call, at this time, we also want to make sure that all our subscribers remain aware of the fact that this is not a market without risk and that caution is never a bad ally when it comes to investing.” We added: “As earning season unfolds, we may see some volatility in individual companies. We would expect some backing and filling along the way and perhaps some increased volatility.” Thus, our caution was on point, as the biotech sector was not spared the consequences of a market wide sell-off.  

The market related selling in the sector was made worse when bad news from high flyer Biogen on two fronts hit the wires. But it seems to us that maybe the news that Anthem (ANTM) is buying Cigna (CI) may have had something to do with the decline in the sector as well. We are on the record as noting that the future for biotech and the expensive drugs developed by the companies in the sector is uncertain in the era of the Affordable Care Act and the transfer of power from companies to third party payers and Medicare. We may be wrong on this, but for now, it makes a whole lot of sense.   See last week’s (July 21, 2015) In Focus article for details on this topic. See more details about Biogen in our news section below.

So what’s a long term investor to do in a volatile sector such as biotech in order to not sell stocks that may do well over the next several years if held? The answer is twofold. First, it’s important to know what the leading dynamics of the sector are at any one time. And right now, we are looking at uncertainty as the major external influence. That means that picking stocks which should be shielded or less exposed to the uncertainty of the implementation of the Affordable Care Act. That’s why our portfolio is full of small medical equipment stocks with strong balance sheets as they have a better chance of earning predictable income compared by big lumbering giants whose expensive drugs may not be paid for at their asking price by powerful insurance companies with tight purse strings and an equally cost aware Medicare.

Second, for those who are comfortable with leverage and close supervision of their portfolio it makes sense to own shares in the ProShares Ultrashort Biotech ETF (BIS).   Note the charts of BIS (left ) and NBI (right). They are nearly 100% opposite mirror images, which validates our point about considering the use of BIS as a portfolio hedge.

We do want to make this point very clear. BIS is not an investment ETF but a trading ETF. Its price changes at 2x the rate of the Nasdaq Biotech Index (NBI), our benchmark for our biotech portfolio.   However, it does come in very handy when you are trying to keep your portfolio’s total value from falling as its price does rise when NBI falls.  

Everyone’s risk tolerance is different. And there is no one way to use this ETF due to its volatility. Our point in this missive is to highlight its existence and to inform our subscribers that it may come in handy if the overall market continues to sputter. A good method may be to buy shares of BIS based on the value of the biotech portfolio. For example, if you wish to reduce your losses by 20-30% of the value of a $10,000 portfolio, it may make sense to buy $2-$3,000 worth of shares of BIS.   This ETF is volatile, as it is designed for day trading. Therefore owning shares in it may not be for everyone. But for those subscribers whose level of experience and risk tolerance allows owning it, it may make sense in a turbulent market. As always read the prospectus for details before investing. Dr. Duarte uses BIS in his own biotech portfolio.

For further reading on portfolio protection techniques and risk management consider a copy of Dr. Duarte’s “Trading Options for Dummies.”

In Depth: Updated EBIS (Emerging Biotech Investment System) Pick: Masimo Corporation (MASI)

New Pick: Masimo Corporation (MASI) – Buy up to $44.

Market volatility could provide a nice entry point into this stock. Masimo Corporation could move decidedly higher as it approaches its earnings release on August 5 at 4 P.M. It could also fall in price, given the current circumstances in the market. Yet, this small company is similar to our other biotech portfolio picks. MASI is a well run company with plenty of cash on its balance sheet and a growth agenda. We like Masimo because it has innovative products, an excellent growth rate, and a nice stash of cash on its balance sheet which it could use to make acquisitions or to plow into research and development. What that means is that the company’s got time to deliver on its products and get it right.

Masimo manufactures equipment modules that monitor vital signs during difficult clinical and logistical circumstances. Thus, it provides solutions that could make the difference in life or death decisions. Masimo pioneered Signal Extraction Technology (SET) a process that lets the pulse oximeter measure the oxygen content of blood without punctures of arteries at states of low blood pressure, where it become a most critical piece of data. Pulse oximeters are non-invasive, clip-on devices usually placed on fingers, toes, or ear lobes and are used to measure the amount of oxygen in the blood during anesthesia and during patient stays in the intensive care unit. They are increasingly being used in non invasive care units as well in order to measure the oxygen concentration of patient’s blood when they are under the influence of opioid painkillers.

The company also has other product lines aimed at the operating room and intensive care arenas that involve monitoring of gases, such as oxygen and carbon dioxide as patients breathe. Masimo is starting to make headways into the length of stay and complication rates of patients during surgeries because its equipment is more accurate in measuring key data than its competition. This puts it in a good position, given the global push, but also the ACA related push in the U.S. toward lower costs in hospital stays.

The EBIS Score for MASI is 9.5 based on April 4, 2015 data.   MASI will report earnings on August 5, 2015 at 4:00 P.M. Estimates are for $147.93 Million in revenues and 30 cents in earnings per share. Here are the EBIS details:

  • Cash on hand: (+1) MASI reported some $135, 720 million in cash compared to $97 million in the June quarter of 2014.
  • Cash on Hand growth (year over year) (+1): The year over year cash grew by 39%.
  • Revenues (present or not): (+1): The company delivered a 9.7% revenue growth rate in its April quarter compared to the year earlier.
  • Revenue growth (10% or greater): MASI gets a 0.5 on its revenue growth rate of 9.70%, just missing our target of 10%.
  • Trailing Total Liabilities/Current Assets (<1=+1 , >1=0): (+1)MASI has a 80% worst case scenario ratio. That means it
  • Earnings (Present or Not Present): (+1): MASI had a 48% year over year growth rate on earnings as of April 2014.
  • Net Income Growth (Year over Year): (+1): The company has delivered sequential earnings growth for three of its last quarters.
  • Products on the market: (+1): MASI is growing its market share with its wireless systems.
  • Pipeline Strength: (+1): MASI is tight lipped about its pipeline but continues to launch new products as well as continuing to look for acquisitions.
  • Late Stage Clinical Trials and Product Launches: (+1): Recent product launches include herpes virus detection and its Para Pak single vial sample transport kit.

The EBIS system consists of eleven fundamental criteria that are updated every quarter after the earnings results for each company are published. Each criterion gets a value of +1 or zero. A total of 8 or more points earn a Buy rating. A total of 5-7 points earn a Hold rating. Less than 5 points delivers a Sell or Avoid rating. EBIS was introduced in the June 15, 2015 issue of the Biotech Report.

Portfolio Update:

Update: Meridian Biosciences (VIVO) Buy up to $21; 7/24/15 closing price $18.70. EBIS Score 9.5.

Earnings/Dividend update: VIVO met its earnings expectations on 7/23 but fell short on its revenues estimates. The company delivered net income of $9.1 million, 22 cents per share on revenues of 48.2 million vs. expectations of 48.9 million. Management reaffirmed expectations for the full year of revenues of $193 to $200 million. The stock sold off initially but regained its ground.  Vivo will pay a dividend of 0.2 per share on July 20th.

VIVO has a market cap of $767 million but is a consistent money maker. The company develops, manufactures, and markets diagnostic testing kits focused on gastrointestinal infections, virus detection, and parasitic illnesses. It also produces reagents and key testing and DNA amplification and enzyme related materials used in research. It has recently released a new product, the Para Pak single vial transport system for parasite testing which simplifies the transport of samples to the lab by using one vial instead of the more complicated multiple package systems that are currently on the market.

We expect VIVO to benefit from the global immigration trend and the potential for infectious diseases to expand their territory via travel related transmission channels. The company has a well established global platform including a recently opened office in Beijing (January 2015). Dr. Duarte owns shares in VIVO.

Neurocrine Biosciences (NBIX) (BUY 6/16/16 at 46 – 7/24/15 closing price 51.50 – Sell Stop 40) Neurocrine Biosciences held up much better than the biotech sector on the week ending on 7/24. The sell stop has been raised to 40. The stock has the potential to move to the 55-58 area over the next few weeks. We originally highlighted NBIX in our 5/29/15 update. We like the stock based on the prospects of its Elagolix drug for treating endometriosis a condition of pre-menopausal women linked to the menstrual cycle and pelvic pain. Dr. Duarte owns shares in NBIX.

Neurocrine Biosciences will report earnings for its most recent quarter on August 6, 2015 at 8:30 A.M. Estimates are for revenues of $650,000 and a loss of 29 cents per share.

Repligen (RGEN) Buy until $44. Sell Stop at $32.

Repligen (RGEN) (Trading Buy 4/20/15 – MPP $33.23. Buy 5/11/15 MPP Price $38.45 – 7/24/15 Closing Price $40.46) – Repligen will be reporting earnings on August 4th. The stock broke below support at $37.50 on 7/24 as the news of Biogen’s problems hit the wires. RGEN is the world’s leading producer of Protein A, the basic component of monoclonal antibodies used for research and biopharmaceuticals manufacturing. Biogen and other major drugs are based on monoclonal antibodies (MAB). If the number of new MAB drug candidates decreases it could affect RGEN’s earnings for the future.

The earnings estimates for the most recent quarter are fairly modest, so it is plausible to expect a beat, although no one ever knows. It will be interesting to see what the company says about its future growth expectations given the MAB situation. In a recent presentation, spring 2015, the company reiterated its expectations for rising organic growth rates in the 25-29% range due to recent and scheduled product launches. The company also noted that they have 350 potential molecules in their pipeline. Dr. Duarte owns shares in RGEN.

Repligen will report earnings for its most recent quarter on August 6, 2015 at 8:30 A.M. Estimates are for revenues of $20.05 Million and earnings of 8 cents per share.

Emergent Biosolutions – Buy up to $34.

Emergent Biosolutions (EBS) (Buy 5/11/15 MPP* $30.63 – 7/24/15 Closing price $32.81) – EBS shares remain in a very sustainable looking up trend. EBS announced a $19.7 million two year contract from the Biomedical Advanced Research and Development Authority (BARDA), an agency of the U.S. Department of Health and Human Services, on July 20th. EBS also makes BioAnthrax, a preventive anthrax vaccine and is working on a new generation of the vaccine. Dr. Duarte owns shares in EBS.

EBS will report earnings for its most recent quarter on August 3, 2015 at 4 P.M. Estimates are for revenues of $124.25 Million and earnings of 26 cents per share.

Bio-Rad – Buy Limit Raised: Buy up to $155. Sell Stop at $138.

Bio-Rad Labs (NYSE: BIO). Buy (5/18/15 – MPP) $146.25 – 7/24/15 closing price $148.41). Bio-Rad has been in a consolidation pattern in the last few weeks and is giving investors a rare second chance to enter at the original buy area near $146. Bio-Rad has its earning scheduled to be released on August 4th. The company makes testing equipment. BIO is expected to introduce a new line of diabetes testing equipment in Europe this fall and has recently received FDA approval for a high speed diabetes testing system in the U.S.

Bio-Rad will report earnings for its most recent quarter on August 6, 2015 at 4 P.M. Estimates are for revenues of $498.85 Million and earnings of 78 cents per share.

Update: Trend Following ETF Model

Alert: Due to the volatility of the IBB ETF we are pulling it from the trend following portfolio and concentrating on PBE, which is less volatile and is more conducive the small stocks that we have in our portfolio.

  • Alert:   ProShares Dynamic Biotech and Genomics ETF (PBE) (Buy 5/11/15 MPP $55.80 – 7/24/15 Closing price $59.06.) Sell stop at $52
  • Alert: ProShares Ultrashort Biotech ETF (BIS) – Buy until $29. Stop Loss at $25.

Dr. Duarte owns shares in PBE and BIS.

Results of trades in Trend Following Model

I-shares Nasdaq Biotech ETF (IBB) (Buy 5/11/15 MPP 352.96 – Sell stop triggered at $363 on 6/29/15 for gain of 2.84%.

I-shares Nasdaq Biotech ETF (IBB) (Bought 7/7/15 at 375 – 7/24/15 closing price $377.78. Sell stop hit at $380. Gain 1.33%.*MPP – Median Purchase Price

News Update:  Biogen’s Double Nasty Sinks Biotech Sector

Shares of Biogen (BIIB) got clobbered last week as the results of its Alzheimer’s drug aducanumab failed to impress during its presentation on Wednesday July 22nd. The stock lost 19 points on the news and then the bottom dropped out on 7/24 after the company disappointed on its outlook and future expectations. All said, Biogen shares dropped from 410 to 300 in two days, a loss of over 25%.

As we noted, our EBIS portfolio member Repligen is the leading manufacturer of protein A, the building block of antibody based drugs. Thus, it was no surprise to see RGEN fall as well.

Investments Portfolio Update – Western Digital (WDC)
by Linda McDonough, CFA

Have you seen the video of the frustrated monkey tossing his laptop against the wall as he waits for it to boot up?  Humans are generally less patient and have come to expect almost instant processing power from their computers.

Thankfully Western Digital (NSDQ: WDC) has been incorporating new solid state disk (SSD) technology into its computer drives to ensure all laptops and desktops remain firmly grounded to their owners’ desks.

Smart Tech Investor is no stranger to Western Digital.  We had a short but profitable tryst with the stock back in December 2013 when it was added to our inaugural portfolio in the low $80s.  A rapid and steep surge in the stock left us no choice but to cash out in August 2014 with a quick 25% gain and await better prices.

That time has arrived.  Smart Tech Investor added Western Digital to the Investment Portfolio on July 7th with a buy recommendation up to $82. Western Digital’s stock has been battered this year as the industry digests slower PC sales.  Part of the decline in PCs has been due to the tsunami of smartphone sales.  These clever little devices encapsulate almost all the functionality of a basic laptop and are a mandatory appendage for most citizens in the developed world.  Tablets and smaller form devices have also soaked up some of the consumer demand that had previously been destined for PCs.

The other factor behind the most recent softness in PC sales has been the deterioration in Europe’s economy.  Just this past March, chip maker Intel blamed the downshift in European macro conditions on limp demand from small and medium-sized businesses overseas.  The dollar, which has grown increasingly strong due to Grexit fears, makes computer imports more expensive outside of the United States, weighing on foreign demand. Finally, the Windows XP refresh which drove demand in 2014 is not available this year to help boost sales.

Luckily, Western Digital, who manufacturers the hard drives that set our computers in motion, has been busily innograting new technologies focused on faster growing enterprise and cloud storage sectors into its portfolio.  Western Digital’s watershed acquisition was its March 2012 purchase of Hitachi Global Storage Technologies (HGST).  HGST gave WDC instant access to the development and production of next generation solid state drives (SSDs).

Before this purchase, the bulk of WDC’s energy was spent on hard disk drives (HHDs), computer components that wrote and retrieved data from the magnetic coating on a spinning metal platter. While advances have allowed these devices to shrink in size and grow in capacity, improvements in HHDs have slowed down due to technological limitations. More dramatic innovation has been in SSDs, which have shrunk in size considerably while becoming faster and more durable.

Although the functionality of SSDs is basically the same as HDDs, the efficiency and reliability of these drives is significantly better than HDDs.  Anyone with an older computer can attest to the dreaded whirring of a hard drive spinning as it attempts to boot the system up.  A read/write arm on a moving head of the HDD accesses data from a spinning disk. Because HDDs rely on moving parts to function, they are much slower in retrieving the data necessary to launch a start-up menu or to pull up a large spreadsheet.  They are also more fragile and can break if jostled around.  If you’ve lost data after dropping your laptop, you likely have an HDD handling the data storage and recovery.

In an SSD, data is stored on a web of interconnected flash memory chips.  These chips can be permanently installed on a motherboard or a PCI card.  The lack of moving parts combined with the flash memory allows SSDs to obtain data almost instantly.  A laptop using an SSD will usually boot up in seconds versus a minute or more for one powered by an HDD.

Despite their inferior performance, HDDs are still used more often than SSDs in most computers.  This is partly due to the inertia of PC manufacturers who simply keep ordering what works and is cheap.  Although SSDs are becoming more prevalent, they are still more expensive than HDDs.  Over time, SSDs, which can be shrunk to sizes much smaller than HDDs, will become more ubiquitous.  WDC s already seeing huge growth in this sector, reporting that its enterprise SSD business was up 67% in the March quarter.

As with many large tech companies, the seismic shifts in smaller business are not entirely visible to investors.  As HDD composes a much larger portion of Western Digital’s revenue, declines in this business overwhelm the growth happening in the smaller SSD division.  After enjoying double digit revenue growth in 2012 and 2013, which was propelled by the inclusion of HGST (the acquisition straddled both fiscal years), WDC has most recently seen a slight decline in revenue and earnings.  

Yet the stock and current estimates already incorporate lower numbers going forward.  Despite its remarkable ability to generate significant cash flow every year, Western Digital trades for 10 times next year’s earnings.  The company has generated $12.5 billion of cash flow over the past 5 years and $2.5 billion in the last 12 months.  As the HDD business levels out with Europe’s slow recovery, overall revenue growth should resume.

Even after spending $1 billion on stock repurchases and $350 million in dividends over the past 12 months, Western Digital has enjoyed the financial flexibility to continue acquiring evolving technologies. It has folded in 4 additional companies since the 2012 HGST purchase. The most recent being Amplidata in March.  All of these acquisitions have technology that focuses on SSD and will allow WDC to continue the transition into a premier provider of storage solutions for cloud and enterprise customers.

Western Digital’s consistent and generous cash flow, its 2.3% dividend yield and its proven hunger to continually transform its technological stronghold have earned it an above average STR of 8.3, the 5th highest rating of any of the stocks in our universe.  As consumer and enterprise desire for immediate access to increasingly sophisticated data soars, Western Digital will be there with the hardware to facilitate and fulfill these hefty demands. Western Digital is a Buy up to $82.

NASDAQ Composite Index:                                                                       

Friday, July 24 = 5,088.63                                                 

Trailing 12 months = + 14.8%                                        

Trailing 4 Weeks = + 1.6%

Trailing 7 Days = – 2.3%            

Weekly Portfolio Performance    

STI Portfolios
INVESTMENTS(close px)(close px)
3CA TechCA$30.53$29.08-4.75%
12Western DigitalWDC$78.93$77.26-2.12%
Portfolio Average-3.60%
NEXT WAVE(close px)(close px)
2Lattice SemiconduictorLSCC$5.89$5.00-15.11%
4Nice SystemsNICE$64.47$63.04-2.22%
5Nimble StorageNMBL$27.49$27.670.65%
6Paycom S’warePAYC$35.07$33.75-3.76%
7Silicon MotionSIMO$30.53$28.62-6.26%
10Varonis SystemsVRNS$23.94$23.41-2.21%
Portfolio Average-0.16%
MEDICAL PROFITS(close px)(close px)
2Ekso BionicsEKSO$1.11$1.10-0.90%
3Emergent BiosolutionsEBS$34.44$32.81-4.73%
4iShares NASDAQ BiotechIBB$397.59$377.58-5.03%
6Meridian BiosciencesVIVO$19.54$18.70-4.30%
7Neurocrine BiosciencesNBIX$53.51$51.50-3.76%
10PowerShares Dynamic BiotechPBE$62.77$59.06-5.91%
11Repligen CorpRGEN$40.46$35.82-11.47%
12ReWalk RoboticsRWLK$10.53$10.38-1.42%
Portfolio Average-3.40%