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While some health care and biotech stocks have recently fallen out of favour, analysts say the innovation and profits created over the last two years are being deployed in new areas.gorodenkoff

As companies focused their research and distribution efforts on combatting COVID-19, the health care and biotech sectors were front and centre for investors earlier in the pandemic. But while some stocks have recently fallen out of favour, analysts say the innovation and profits created over the last two years are being deployed in new areas, which will drive medium-term growth in pockets of the sector.

In the biotech space in particular, says Eden Rahim, portfolio manager and options strategist with Next Edge Capital in Toronto, the COVID-19-related trade – focusing on producers of COVID-19 vaccines and treatments, is over. The sector, he says, experienced three waves of being in favour, starting in March, 2020. The first wave buoyed all players in the space. The second wave, in the latter half of 2020 and into 2021, saw companies that generated revenues and therapies move higher. The final surge in mid-2021, however, only involved vaccine makers, such as Moderna Inc. and BioNtech SE, whose share prices have since declined. When the Omicron wave hit in late 2021, COVID-19-related biotech stocks barely moved, says Mr. Rahim, although many companies were still reporting positive revenue numbers – a sign, he says, that the market has moved on.

The Nasdaq Biotechnology index, for example, has fallen about 17 per cent over the last year, after returning more than 26 per cent in 2020. The sector has been affected, not only by the pandemic passing its peak, but also by factors such as excessive supply from record initial public offerings (IPOs) and secondary financings.

Despite a more difficult ecosystem in biotech at the moment, the last two years caused a number of foundational shifts in the sector, says Mr. Rahim. The vaccines and treatments developed for COVID-19 resulted in several benefits, such as opening the door for shorter timelines to bring therapies to market, as well as future applications for messenger RNA (mRNA) vaccines for other viruses and oncology – a technology he says is “completely revolutionary” for its efficacy and scalability.

“These effectively lower the cost of capital, they will bring therapies to market in a shorter period of time … at lower cost and so, these are shifts that are occurring that investors haven’t really priced in yet,” he says.

As opposed to earlier in the pandemic, says Mr. Rahim, the market has started to distinguish companies with good revenue growth expected over the next several years from earlier stage firms with larger funding requirements. He is bullish on higher quality growth companies that are addressing unmet needs, such as those focusing on central nervous system conditions like Alzheimer’s and Parkinson’s disease, Amyotrophic Lateral Sclerosis (ALS) and schizophrenia.

“[Investors are] looking through the peak of COVID and then the leaders that are emerging now, thankfully, are those companies that are developing breakthrough drugs that have a really good revenue outlook over the next few years because of these new FDA [U.S. Food and Drug Administration] approvals and commercialization launches, so it’s a little bit back to normal in the sector.”

The non-cyclical growth qualities for many health care and biotech companies give the sector a defensive element, says Mr. Rahim.

“I’m really optimistic about where this sector goes a year from now. It’s been through a 50-per-cent bear market – they occur infrequently and when they do, it always represents a tremendous buying opportunity,” he adds.

For companies that have benefited from COVID-19 therapies or testing – such as Pfizer Inc., Eli Lilly and Co. and Thermo Fisher Scientific – a decreasing focus on pandemic-related treatments means that they have experienced the peak of those sales, says Ashtyn Evans, a St. Louis-based Edward Jones senior equity analyst covering the health care sector.

The exception, she says, may be Pfizer, which will likely see its COVID-related sales peak this year. In its 2022 guidance, Pfizer forecast revenues of US$32-billion for Comirnaty, Pfizer’s COVID-19 vaccine developed in partnership with BioNTech, and US$22-billion for its oral COVID-19 treatment, Paxlovid. The company reported more than US$42-billion in vaccine revenues in 2021.

“We think there will be sales of those products over the near to medium term, but that there will be a pretty significant drop off each year for those products as we pass the pandemic and enter the endemic stage,” she says.

But even as the focus on COVID-19 treatments wanes, Ms. Evans says companies will experience a long-term benefit from the profits they’ve earned from these products, which have put many in strong financial positions and ready to invest.

“The cash inflows they’ve seen over the last couple years and that they’ll see over the next couple years really gives them a lot of flexibility to invest internally in drug development and externally through acquisitions,” she says.

Looking ahead, Chelsea Stellick, Calgary-based iA Capital Markets senior equity research analyst focused on health care and biotech, expects the testing sector to continue to have applications post-pandemic. While testing control companies like Microbix Biosystems Inc. saw significant demand during COVID-19, the need for testing is expected to continue or pick up for other conditions after being put on hold due to the pandemic, she says.

One sector that didn’t do as well expected during COVID-19 was health care technology, says Ms. Stellick. Although companies experienced a boom at the start of 2021 with a number of IPOs, mergers, and acquisitions as investors saw virtual care as the new reality, stock prices declined later on as online fatigue hit and people took the opportunity to visit their physician in person if they could, she says.

In the post-pandemic era, Ms. Stellick expects this sub-sector to gradually bounce back.

“We’re going to see a slow build of the health care tech and that’s because at the end of the day people still value convenience,” she says.

In the meantime, says Ms. Stellick, current macroeconomic conditions, including the war in Ukraine, mean many investors are currently risk-averse – which may leave health care and biotech out of the spotlight for now, even with more favourable prices.

“That’s already impacting us in the first quarter – we haven’t seen any deal flow, or hardly any deal flow, because companies are holding back, they’re not going to issue equity at these prices. And so, I think that’s going to loom probably until the end of the first half of this year,” she adds.

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