The End of the Beginning

Quite frankly, we are not disappointed to see last week’s stock market plunge once again call into question the advisability of owning so-called “momentum stocks.” The tech sector stopped being dependent on momentum a long time ago, but it seems only now are some investors getting that memo based on last week’s sell-off. 

In addition to Apple – which meets just about every textbook definition of a “value stock” that you will find – there are dozen of tech stocks that generate huge profits and will continue to do so, even in the face of China’s economic slowdown and/or an interest rate hike from the Fed. That is not to say that there are no longer any overvalued tech stocks – as there most certainly are – but they now comprise an decreasingly small minority of the sector.

However, the biotech space still has a fair amount of momentum left in it, so its important that you know how to differentiate between a company on a high growth curve versus one with deteriorating fundamentals that the rest of the world hasn’t caught on to yet. That’s why we added Dr. Joe Duarte to our team earlier this year, as we knew his expertise could be invaluable in terms of identifying future biotech winners and losers (Dr. Duarte’s article appears below).

As Winston Churchill famously said, “Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.” While that statement was made in November of 1942 at the height of World War 2, we think it could also apply today to the way in which tech stocks have gone from being overvalued upstarts to mature businesses that can carry the U.S. economy – and its stock market – to new heights for decades to come.

We expect one more leg down in the stock market correction this year, triggered by the Fed whenever it decides to begin raising interest rates. To be clear, we aren’t expecting a crash, but we wouldn’t be surprised to see another 5 – 10% selloff before the bloodletting is over. But once that happens, the stage should be set for a long term bull market led by the tech sector. In other words, the current stock market correction is not the beginning of the end, but just the end of the beginning.

Portfolio Update – Medical Profits

By J. Duarte MD

In this issue:

  • The Big Picture: Volatility and Confusion Reigns
  • In Depth: New EBS Pick – Greatbatch Inc. (GB) Surges Behind Surprise Acquisition
  • EBIS Portfolio Alerts: Alert: EBIS Portfolio Pricing Update
  • News Update: Analysis: Amgen’s Cholesterol Gamble and Some Interesting ACA Data

The Big Picture:  Volatility and Confusion Reigns

When we wrote “Investors may be in for a wild ride over the next few weeks to months if the 531 point decline in the Dow Jones Industrial average drop of August 21st is any indication of what could lie ahead” in our 8/24/15 issue we had no idea that the market would push the boundaries of credibility with yet another Flash Crash on the next trading day.  But that’s where we are these days, in the realm of the unbelievable, which is why we have steered away from the more volatile traditional areas of biotech whose focus is on companies with product cycles and fortunes that depend on expensive high risk research and whose big pay days are dependent on clinical trial results and FDA decisions.  To be sure, there is a time and place for everything. And those companies will have their day again. It’s just not quite the time for that type of risk at this moment, even if there is a significant rally in this area of the biotech sector in the short term. 

NBI biotech index 2015 08 31BIS biotech index 2015 08 31

The biotech sector, as measured by the Nasdaq Biotech Index (NBI), went along with the market for its wild ride last week but did bounce back to close the week inside the 3500-3900 trading band which had been its previous support level.  The chart clearly shows that NBI closed above its 200-day moving average on Friday, but reversed course on Monday calling the overall trend – up or down – into question at this point.   Compared to the chart of the ProShares Ultrashort Nasdaq Biotech ETF (BIS) you can see that BIS did its job well, moving in the opposite direction of the NBI index and providing a portfolio hedge during the volatile period, extending into Monday.  Thus, it is possible that we could see a retest of the recent market lows and possibly even another break to new lows. 

Thus, because of the current state of the markets and the overall state of the biotech sector, our strategy remains unchanged:

  1. Monitor the price of all current positions in your biotech portfolio. If your biotech stocks are not being aggressively sold off and sell stops don’t get triggered, keep them in your portfolio.
  2. Watch the response of your positions to external forces, especially the Fed, China’s economy, and the current political climate.  Always monitor your portfolio’s response to the market and only sell stocks that are showing significant weakness and fall below their sell stop.
  3. Consider using BIS to hedge your biotech portfolio during periods of weakness for the market and the biotech sector. Our July 27th, 2015 update has an excellent tutorial on how you may go about doing this.  Also, see below for our latest BIS recommendation.  For further reading on portfolio protection techniques and risk management also consider a copy of Dr. Duarte’s “Trading Options for Dummies.”

In Depth:  New EBIS (Emerging Biotech Investment System) Greatbatch Inc. (GB) Soars on Acquisition Details

Alert New Pick:  Greatbatch Inc. (GB) – Buy at 51-55.  Sell Stop 44.

Greatbatch Surges Behind Surprise Acquisition

Greatbatch surprised the market on 8/27/15 when it announced that it was buying privately held medical equipment maker Lake Region Medical for $1.73 billion in cash and stock.  The merger expands Greatbatch’s market share in the outsourced medical equipment manufacturing sector to the 10-12% range. It also increases its exposure to big customer names like Medtronic (MDT), Johnson & Johnson (JNJ) and St. Jude Medical (SJM), all big players in the cardiac pacemaker and related areas. 

As we noted in our initial coverage of the stock (8/17/15), Greatbatch is a restructuring story which, at the time we began coverage, looked “ready to move higher over the next 6-12 months.”  It looks as if management didn’t want to wait that long to make the stock rise. The company manufactures medical equipment under contract to original equipment manufacturers with a focus on the cardiac pacemaker, orthopedics, and spinal cord stimulation segments.  GB also has a defense contract division, which gives our EBIS portfolio an interesting edge, since Emergent Biosolutions (EBS) is a major player in vaccines and has a large government and military contract base with its Anthrax and Smallpox vaccines.

GB received an 8 EBIS rating, garnering a BUY recommendation.  Now, we have to see what the stock does over the next few weeks and months as the company consolidates its new purchase. We will be paying special attention to the balance sheet and future earnings, as well as how much debt the company has to take on to finance the Lake Medical purchase.  We still like the company because it has proven that it can make money a in a challenging environment.  Yet, it has clearly been busy over the last few months and it has a lot to consolidate.   Consider the following:

  1. GB is spinning off its spinal cord stimulator business into a separate company it will call Nuvectra, while it continues to generate revenue from manufacturing the equipment for Nuvectra. It’s uncertain what it GB will do with the spinal cord stimulation business that it will get with the Lake Regional purchase.  Spinal cord stimulation could become troublesome and it may turn out to be a money loser or a reduced revenue generator under the Affordable Care Act, despite the fact that it may be expanding its focus beyond pain management into the treatment of paraplegia.   

This is a key point, though.  Spinal cord stimulation is moving toward a new innovation phase, as implantable devices will be moving toward an external wireless control model based on mobile phones. This means that patients will no longer have to have a battery implanted along with the leads that deliver the stimulation to the spinal cord. What this may have to do with the acquisition remains to be seen. 

  1. Prior to the Lake Medical acquisition GB bought CCC Medical, enhancing its cardiac neuromodulator equipment line and has already seen an increase in sales contribution from the acquisition. Cardiac remains profitable for now. We could see a similar situation develop with the Lake Medical acquisition.
  2. GB has been growing its orthopedics equipment business. Although the Affordable Care Act could lead to some pricing pressure on this line of products, the demographics for joint replacements are only improving as the population ages. Also, the trauma related product line, including equipment to repair fractures, could benefit from defense related developments in the future if the geopolitical climate worsens.
  3. The company is still on schedule to move significant manufacturing capacity to Mexico, expecting significant cost reductions and a positive contribution to the bottom line. This could be a negative in the current political environment but it is something that could lower costs and increase earnings for GB.
  4. Most of the company’s product lines are growing except for the vascular related segment, which is separate from its cardiac product line. In its recent conference call, the company cited improving visibility for this line of business in the second half of 2015 and into 2016; as its customers work through inventory and new products are introduced, especially in GB’s catheter line.
  5. GB has a strong engineering and design team which is addressing issues in the energy sector, including improving design for batteries and exploration equipment. Any turnaround in energy could also provide a boost to the stock price.

Here are the EBIS details:

The EBIS Score for GB is 8 based June 30, 2015 data, prior to the Lake Medical acquisition.  

  • Cash on hand: (+1) GB reported $72.34 million on hand up from $61.58 million in September 2014. 
  • Cash on Hand growth (year over year) (+1): The year over year cash grew by 17.4%.
  • Revenues (present or not): (+1): The company delivered a small revenue growth rate in its June quarter compared to the year earlier. What is important is that its revenues are not falling even as the company restructures.
  • Revenue growth (10% or greater): GB is not growing its revenues currently but has given positive guidance for the second half of 2015 and 2016.
  • Trailing Total Liabilities/Current Assets (<1=+1 , >1=0): (+1)GB has a 0.91 worst case scenario ratio. That means it can cover all of its liabilities in a worst case scenario without borrowing money.
  • Earnings (Present or Not Present): (+1): GB reported flat earnings growth in its June quarter. Again the company is restructuring and still makes money.
  • Net Income Growth (Year over Year): (+1): The company has delivered stable but not growing earnings.
  • Products on the market: (+1):  GB has a broad array of products on the market and a broad customer base.
  • Pipeline Strength: (+1): GB is working with its customers and has a credible pipeline in place.
  • Late Stage Clinical Trials and Product Launches: (+1): The company’s pipeline is nearing launch of new products later in 2015 and 2016.

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:  EBIS Portfolio Survives Crazy Market Week – Suffers Casualties Due to Volatility

Alert:  Our EBIS portfolio triggered some sell stops this past week.  Repligen and Bio-Rad have been removed from the portfolio.  However, due to some potential pricing issues in the Flash Crash on 8/24/15 some of the pricing may or may not have been accurate.  Thus, we are not removing Neurocrine Biosciences from the portfolio but are downgrading the shares to a HOLD. See details below:

Masimo Corporation (MASI) – Buy up to $44.  (Buy issued July 20, 2015. MPP $40.65).  8/28/15 closing price: $41.51

Masimo had a wild week on the week ending 8/28/15.  But the stock found its way back by the week’s end and remains within our buy range.

Masimo manufactures equipment modules that monitor vital signs during difficult clinical and logistical circumstances.   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. 

MASI reported adjusted earnings of 43 cents per share, 13 cents ahead of expectations in the second quarter of 2015, while revenues came in at $ 155 million ahead of the $147.93 million estimate.  The company raised its full 2015 guidance to total revenues of $621 million, up from $608 million and earnings per share from $1.48 to $1.51.    The stock remains well within its buying range of 40-44 and keeps a 9.5 EBIS rating based on its June 2015 quarter.  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. 

Meridian Biosciences (VIVO) Buy up to $21 – 8/28/15 closing price $19.11.

Meridian rallied nicely on 8/28/15 showing some relative strength.

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 remains near the lower part of its trading range.   Vivo paid dividend of 0.2 per share on July 20th. The dividend yield is a nifty 4.4%, while the stock price is not particularly volatile. This is a combination which makes having a long term perspective worthwhile.

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 – 8/28/15 closing price $46.67 – Sell Stop $40)

Alert: Neurocrine is now rated HOLD. Neurocrine hit its sell stop on the Flash Crash but we still like the stock as a speculative play and recommend holding on to the shares if you didn’t use the sell stop. 

Neurocrine Biosciences reported a net loss of $24.0 million, or $0.28 loss per share, compared to a net loss of $13.4 million, or $0.18 loss per share, for the same period in 2014. For the six months ended June 30, 2015, the Company reported a net loss of $25.2 million, or $0.30 loss per share, as compared to net loss of $25.2 million, or $0.35 loss per share, for the first half of last year.   Estimates were for revenues of $650,000 and a loss of 29 cents per share. 

The stock has the potential to move to the 55-58 area over the next few weeks to months.  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 is also advancing phase III clinical trials of its NBI-98854 drug aimed at the degenerative neurological disease tardive diskynesia.   Neurocrine expects further input on Elagolix by early 2016.

Neurocrine is a speculative stock. This is a research stage company with no products on the market but several potential blockbusters at key stages of development and nearing the FDA approval process.

Alert:  Repligen (RGEN) Stopped out at $32 (8/21/15).

Repligen (RGEN) (Trading Buy 4/20/15 – MPP $33.23. Buy 5/11/15 MPP Price $38.45 – 8/21/15 Stopped out at $32.  Return (-) 3.84% on a Trading basis.  Return (-) 16.15% on Buy recommendation.

Repligen hit its sell stop on 8/21/15.  It is now rated Sell.

Upgrade: Emergent Biosolutions – Buy until $36.

Emergent Biosolutions (EBS) (Buy 5/11/15 MPP* $30.63 – 8/28/15 Closing price $34.64) –EBS reported earnings of 36 cents per share for its second quarter of 2015 beating analyst estimates of 26 cents.  Revenues climbed 14% from the year-ago period to $126.1 compared to an estimate of 124.25 million.   The company also announced that it will spin off its biosciences unit, whose focus is oncology to investors.   See our news section for details and commentary below.

EBS has held steady in a very volatile market over the last few weeks. We are upgrading its buy range to 36.

EBS announced receiving a $44 million contract from the Centers for Disease Controls to increase the supply of smallpox vaccine.  The previous week EBS announced a $19.7 million two year contract from the Biomedical Advanced Research and Development Authority (BARDA) on July 20th  an agency of the U.S. Department of Health and Human Services.  EBS also makes BioAnthrax, a preventive anthrax vaccine and is working on a new generation of the vaccine.  Dr. Duarte owns shares in EBS.

Bio-Rad – Stopped out at $138.  Alert:  Bio-Rad is now rated sell. 

Bio-Rad Labs (NYSE: BIO). Buy (5/18/15 – MPP) $146.25 – 8/24/15 stopped out at $138).  Return (-) 5.64%.

Update:  Trend Following ETF Model

Alert: Our remaining biotech ETF, the ProShares Dynamic Biotech and Genomics ETF (PBE) was stopped out on 8/24/15.  We are removing it from our portfolio for now. That leaves the ProShares Ultrashort Biotech ETF (BIS) as the only ETF in the model for now.  It is rated hold.

  • ProShares Dynamic Biotech and Genomics ETF (PBE) (Buy 5/11/15 MPP 55.80 – 8/24/15 Stopped out $48.71. Return (-) 14.55%.
  • ProShares Ultrashort Biotech ETF (BIS) – Buy up to $29. Stop Loss $27. (Buy 7/27/15 MPP* $27.99.  8/28/15 closing price $29.85.)

*MPP – Median Purchase Price

Dr. Duarte owns shares in PBE and BIS.

News Update – Analysis: Amgen’s Cholesterol Gamble and Some Interesting ACA Data

A running theme in this column has been the relationship between the dynamics of the Affordable Care Act (ACA), prices for biotech drugs, and the outcome of the overall changing dynamic in the health care sector. Our goal is not to become politically involved but to deliver investment related conclusions in this very real new world where money talks loudly and where what was once considered a given no longer applies.

That’s why we noticed that the FDA approved Amgen’s new cholesterol drug Repatha, which will carry a $14,100 wholesale cost per year for the biweekly injectable drug, with initially limited indications.  Already, Express Scripts, a leading pharmacy benefits manager is saying that it will expect to negotiate with Amgen before covering the medication. Amgen also faces direct competition from Sanofi and Regeneron’s previously approved Praluent. Praluent is priced at $14,600 per year.

Our second story is interesting on its own merits.  According to a CNBC report, large insurers that provide plans under “raised their prices in 2015 much more sharply—by an average of 10 full percentage points—than smaller competitors on that federal Obamacare marketplace.” The article added “in a dozen major counties across the U.S., a popular kind of health insurance plan tends to be significantly more expensive—by an average of 12 percent—when offered by health-care providers such as hospitals, as opposed to traditional insurers.”  The initial item was the result of a Harvard study, while the second came from a Health Pocket study whose conclusion was “elimination of fee-for-service model in provider-owned health plans not successful in producing the cheapest health plans on average.”

Our conclusion is that we are seeing the early stages of a big fight over money.  The government’s focus in creating the ACA was to cut costs.  Insurance companies and drug companies, who were at the negotiating table seem to have had their fingers crossed behind their backs when they signed on the dotted line.   For investors this creates an uncertain climate with the bottom line, literally, for drug companies essentially becoming more difficult to gauge. 

This should be of concern to anyone who invests in the health care sector.  The flip side, as we have seen over the last few weeks, even in our EBIS portfolio, is that mergers and acquisitions are likely to increase, especially as the specter of higher interest rates from the Fed and an increasing possibility of a very wild and woolly presidential election loom.

NASDAQ Composite Index:                                                                       

Friday, August 28 = 4,828.32                                                  

Trailing 12 months = + 6.4%                                        

Trailing 4 Weeks = – 4.3%

Trailing 7 Days = + 2.6%             

Weekly Portfolio Performance        

STI Portfolios
INVESTMENTS(adj. closing px)(adj. closing px)
3CA TechCA$27.07$27.260.70%
4Cisco CSCO$26.47$26.00-1.78%
10Western Digital WDC$79.44$81.282.32%
Portfolio Average2.87%
NEXT WAVE(adj. closing px)(adj. closing px)
2Lattice SemiconduictorLSCC$3.87$4.259.82%
4Nice SystemsNICE$63.25$62.76-0.77%
5Nimble StorageNMBL$24.34$26.087.15%
6Paycom S’warePAYC$37.93$38.311.00%
10Varonis SystemsVRNS$21.15$19.93-5.77%
Portfolio Average1.87%
MEDICAL PROFITS(adj. closing px)(adj. closing px)
2Ekso BionicsEKSO$1.10$1.3724.55%
3Emergent BiosolutionsEBS$33.48$34.643.46%
7Meridian BiosciencesVIVO$18.26$19.114.65%
8Neurocrine BiosciencesNBIX$43.75$46.676.67%
11PowerShares Dynamic BiotechPBE$52.74$55.445.12%
12Repligen CorpRGEN$33.66$34.291.87%
13ReWalk RoboticsRWLK$9.61$8.46-11.97%
Portfolio Average4.97%