Last Thursday’s visit by the Pope to the home of Wall Street was not enough to keep the stock market out of negative territory, though he can hardly be blamed for the multitude of sins afflicting the global financial market. As if Europe’s faltering economy wasn’t already fragile enough, news that German automaker Volkswagen has been cheating on fuel emissions standards raised concerns that its massive decline in value may carry over to its many vendors and suppliers in that region. There was no unexpected bad news out of China (for a pleasant change), but most its recent challenges were drudged back up to the surface when President Obama hosted a state dinner for China’s President Xi Jinping.

Although the purpose of this meeting was primarily social, both leaders acknowledged they discussed China’s alleged cyber-spying on American companies and government agencies. In a sign of unity and strength, almost the entire Silicon Valley ‘A’ list of CEO’s were in attendance at Friday’s dinner including Apple’s Tim Cook. No details of an agreement were announced; instead, a short statement recognizing the need for a more cooperative relationship was released jointly the two Presidents. It remains to be seen just how long it takes for something like to materialize, but my guess is we won’t see a formal treaty or the like until the next U.S. President is in office since that is the administration the Chinese government will be working with for at least the first fours years – and possibly as many as eight years – after an agreement is reached.

Not to be left out, last Monday presidential hopeful Hilary Clinton opined that drug companies have been engaging in “price gouging”, and that she would include as part of her platform a plan that would limit payments for chronic pain medications while also requiring drug companies to reinvest a portion of profits towards the development of cheaper alternatives. That may be good for consumers, but it’s not so great for publicly traded companies whose implied mandate is to maximize profitability for their shareholders. In his Portfolio Update below, Dr. Duarte discusses these comments in more detail.

Jim Pearce

Portfolio Update – Medical Profits
By J. Duarte MD

In this issue:

• The Big Picture: Biotech:  Crash or Future Bargain Shop?
• In Depth: New EBIS Pick – DYAX Corp (DYAX) – High Risk, High Potential
• EBIS Portfolio under Pressure from Indiscriminate Selling. Alerts Provided.
• News Update: Proposed Clinton Initiative Breaks Biotech Sector

The Big Picture:  Biotech: Crash or Bargain Shop?

The biotech sector fell out of bed on September 25^th hitting the levels that defined the August 24^th low. At this point, it is equally possible that the index will rebound or fall further and there is no real way to predict which way things will go.  What is clear is that if prices break down below the August lows, we could see some very severe selling beyond what’s already happened.  And although that may sound daunting, it could very well be a severe enough bout of selling that it spawns a great buying opportunity at some point in the near future. 

We have been discussing the biotech sector’s potential problems for the past few weeks as the NBI index began to flounder after making a new high in July.   How bad has it gotten? For one thing, the Nasdaq Biotech Index (NBI, top chart) is off 20% from its July highs having lost more than 10% of its value in the week that ended September 25, alone.  Yet, investors who have followed our advice were stopped out of several higher risk stocks before the selling accelerated and have owned shares of the ProShares Ultrashort Biotech ETF (BIS, bottom chart) for the past few weeks, thus are more likely than investors who have not hedged their portfolio to have stemmed the losses.  As the chart on the right shows, BIS is up some 54% from its own August lows, providing some nice protection to any biotech portfolio.

Here is the positive angle.  We monitor a large number of biotech and related stocks.  And many of them are starting to be sold very aggressively.  Some have lost over 50% of their value even though their fundamentals haven’t changed that much, if at all.  Thus, it seems that the market is starting to panic. The real question is whether the market is right or wrong. And the only factor that will answer that question is time.

Why would the market be panicking? Aside from the fact that the Federal Reserve is floundering on interest policy, the U.S. economy is starting to show signs of joining the rest of the world’s slowdown.  There are, however, some biotech and health care sector-specific factors that are starting to come to the forefront as well.   We look at those in some detail in our news and analysis section below.  But here is a hint.  It has to do with the Affordable Care Act and the quest for cutting expenses throughout the health care system.

The selling this past week was severe enough to dent even our low key EBIS portfolio.   But we are not changing our directives at this point.  Continue to follow the key principles that we have been recommending over the past few weeks, and our latest addition to the list.  Above all, stay alert and keep your portfolio hedged by using the BIS ETF.

1. Monitor the price of all current positions in your biotech portfolio. If your holdings are holding their own, 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 27^th, 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.”
4. If you choose to buy new stocks, be cautious. A good method for building positions in a volatile market is to buy small lots of stock over a few weeks to months, depending on the overall trend. When this is coupled with a long term time horizon it’s much easier to weather the volatility.
5. Stay tuned and pay close attention to our weekly updates and any potential alerts that may be issued.

In Depth:  New EBIS (Emerging Biotech Investment System) Greatbatch Inc. (GB) Continues to Surge

Alert New Pick Update:  DYAX Corp. (DYAX) – Speculative Buy Range up to $28.  Sell Stop $21.

DYAX Corp – A High Risk High Potential Reward Diamond in the Rough

DYAX Corp (DYAX) – Speculative Buy issued at $25-28 on September 21, 2015.  Sell Stop at $21. 

DYAX is a perfect example of the type of selling that is ongoing in the biotech sector. Nothing changed with this company, yet it was sold, and it was sold hard.   We are leaving our settings alone for now. 

DYAX is an interesting choice because it’s getting very close to having a real shot for FDA approval for DX-2390, a treatment of Hereditary Angioedema (HAE), a genetic disorder that occurs in 1 in 10-50,000 people.    HAE causes swelling of tissues in the body in response to antigens.  DX-2930 is a monoclonal antibody that blocks kallikrein, a key substance in the chemical reaction in the body that leads to the swelling.  In some cases HAE, especially of the tongue or the airway, can be very serious or deadly.   DYAX already has one product on the market, also aimed at treating HAE; Kalbitor.   Sales for Kalbitor in the second quarter of 2015, at $17.8 million, a 7.2% increase measured year over year

DYAX, although having solid fundamentals for its stage of development as a company, is a high risk stock due to its dependence on niche drugs and potential FDA approval issues.    But it does meet the characteristics of a good EBIS stock, especially since it has lots of cash on its balance sheet and good management.  The company reported some 127 million in cash as part of a 413 million current asset stash on June 30, compared to 110 million in total liabilities and some 22 million in current liabilities. That’s an excellent balance sheet for a biotech company in the research to product transition stage where the huge potential growth tends to start if it is successful.   So barring a major change in its finances and its fortunes, it is likely to have enough cash to withstand an FDA approval disappointment, as a company.  The stock would undoubtedly get crushed if there is a failure at the Phase 3 clinical trial for DX-2390 or the FDA does not approve its drug.

DYAX also has some current momentum in a generally downbeat market, which is a sign of strength.  The company seems to think that it has an above reasonable chance to get DX-2930 approved based on the drug being classified as a Breakthrough Therapy by the FDA.  It has recently signed an agreement with an experienced product manufacturer, Rentschler, a sign that the drug has enough promise to move on to the next step.  Phase 3 clinical trials are expected to start late in 2015.  

Investors should consider the following.   There is no guarantee that DX-2390 will be approved for any condition, or that it will sell well in the current and likely future environment of cost cuts in global health care.  Yet, the company’s cash hoard and the fact that it’s signed on with Rentschler and moving on to Phase 3 with DX-2390 for HAE are encouraging at this point and make for a good very speculative pick.

DX-2390 may also be useful in treating eye swelling related to Diabetes. The company plans to register for FDA approval for that indication in 2016.  It also has two other drug candidates in the pipeline, DX-2507, aimed at antibody mediated diseases and DX-4012, a blood thinner.  

Here are the EBIS details:

The EBIS Score for DYAX is 8 (BUY) based June 30, 2015 data.  

• Cash on hand: (+1) DYAX reported $127 million in cash compared to $32 million in September 2014.
• Cash on Hand growth (year over year) (+1): The year over year cash grew by 396%.
• Revenues (present or not): (+1): Revenues are steady and growing.
• Revenue growth (10% or greater)(+1): Revenues grew nearly 20% on a year to year basis.
• Trailing Total Liabilities/Current Assets (<1=+1 , >1=0): (+1)DYAX has a 0.051% ratio, which means that it could survive a very nasty scenario.
• Earnings (Present or Not Present): (0): DYAX has no earnings.
• Net Income Growth (Year over Year): (0): DYAX  has no earnings growth.
• Products on the market: (+1):  DYAX has one product on the market, Kalbitor.
• Pipeline Strength: (+1): DYAX has a credible pipeline with its DX-2930, DX-2507, and Dx-4012 in late stages of development. 
• Late Stage Clinical Trials and Product Launches: (+1): DYAX is putting together its manufacturing infrastructure for DX-2930 and is planning for Phase 3 clinical trials in late 2015 and into 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 under Pressure

Our EBIS portfolio has encountered a bit of pressure.  Details below:

Greatbatch Inc. (GB) – Buy issued at 51-55 on August 17, 2015.  August 17 entry point at the close was 53.51.  9/25/15 closing price 57.10.  New Buy range 58-62. Stop loss:  Raised to 54.  Dr. Duarte owns shares in GB.

Alert: Stop Loss Added – Masimo Corporation (MASI) – Buy at 40-44.  (Buy issued July 20, 2015. MPP: 40.65).  9/25/15 closing price: 40.18. Stop Loss 34.  Dr. Duarte owns shares in MASI.

Masimo remains within our buying range and has held up well in a volatile market over August and September.  It is a crazy enough market though, so we have added a sell stop. 

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; 9/18/15 closing price $17.09.  Dr. Duarte owns shares in VIVO.

Meridian remained slipped outside its buying range on the week that ended on 9/25/15.  We remain positive on the stock but would be patient before buying more at this point.

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. 

On September 9, management adjusted expectations for the full year of revenues of $195 to $200 million and expects revenue growth in the 3-5% range with earnings in the .86 to .90 cents range for the full fiscal year. The stock remains near the lower part of its trading range.   Vivo paid dividend of 0.2 per share on July 20^th. 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 near $800 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.

Alert: Sell stop triggered at 42. Neurocrine Biosciences (NBIX) (BUY 6/16/16 at 46 – 9/25/15 closing price 40.76 – Sell Stop was 42).  Loss: -8.69%.

Alert: Neurocrine has triggered its sell stop and will be removed from the portfolio.

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.

Emergent Biosolutions – Buy up to $36.

Emergent Biosolutions (EBS) (Buy 5/11/15 MPP* $30.63 – 9/29/15 Closing price $29.43). Dr. Duarte owns shares in EBS.

EBS showed some weakness on the week that closed 9/25/15.  There are no major news to report with this company.  We recommend patience when considering whether to buy this stock at this point or when adding to existing positions.

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 showed some weakness in the week that ended 9/4/15.  We are still constructive on the stock but are watching its activity very closely. 

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 20^th  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.

Update:  Trend Following ETF Model

We are still holding the ProShares Ultrashort Biotech ETF (BIS) as the only ETF in the model for now.  It is rated hold.

ProShares Ultrashort Biotech ETF (BIS) – Buy until 29.  Stop Loss 27. (Buy 7/27/15 MPP* 27.99.  9/25/15 closing price 37.27.)  Stop loss on part of the position at 33. 

*MPP – Median Purchase Price

Dr. Duarte owns shares in BIS.

News Update and Analysis – Clinton Proposal Crunches Biotech Sector

The biotech sector was starting to show a bit of weakness when, on Monday, September 21, 2015, Democrat presidential candidate Hillary Clinton tweeted that drug companies were “price gouging” consumers and that she would have a plan by the next day to counter.  Her plan had two major tenets. 1) Limit the out of pocket costs that chronic pain and chronic condition patients would pay per month to keep their medications to $250 per month, and 2) mandate drug companies to put a specific portion of their profits toward drug development.

To be sure, the tweet was in response to a small drug company raising the price of a very old anti-parasitic disease drug from $13.50 a pill to over $700 overnight.  And yes, that is worth noting.  Still, the bottom line for us is what happens to biotech stocks and their prices. And in this case, the selling was huge both in aggressiveness, as well as in the amount of damage done to the sector.

Consider that Mrs. Clinton is not yet the President of the United States and that her poll numbers are not what they were a few months ago.  Yet, you can’t argue with the cause and effect of the events.

So what’s the bottom line? This is not a political analysis.  But politics is an important external influence on biotech stocks. That being said: this is the election season.  The Affordable Care Act has created an environment where there are not enough resources to cover all conditions. Companies with expensive drugs, whether they are high priced drugs for good reason or not, will be targeted.  That much was clear on the week that ended on 9/25. 

NASDAQ Composite Index:                                                                       

Friday, September 25 = 4,686.50                                                  

Year to Date = + 13.1%                                        

Trailing 4 Weeks = + 0.1%

Trailing 7 Days = – 2.9%             

Weekly Portfolio Performance