Biotech sector showing signs of a return to life

Investec still not cheap enough; The heat's still on at Enodis
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The Independent Online

Might there be signs of life in the biotech sector? These highly speculative drug development companies have been down on their uppers for so long, many investors have forgotten they exist. But there is a growing feeling that next year will see a wave of deals to revitalise the sector, if only because many companies are going to run out of money otherwise. Many people hope that will spark an across-the-board revival, but it is far from guaranteed. Individual stock picking remains the best way to play the sector.

Might there be signs of life in the biotech sector? These highly speculative drug development companies have been down on their uppers for so long, many investors have forgotten they exist. But there is a growing feeling that next year will see a wave of deals to revitalise the sector, if only because many companies are going to run out of money otherwise. Many people hope that will spark an across-the-board revival, but it is far from guaranteed. Individual stock picking remains the best way to play the sector.

An interesting study by the respected biotech team at WestLB Panmure argues that more than half the companies listed in the UK are significantly undervalued. In Europe as a whole, there are 169 new drugs being trialled on humans in companies whose total market value is £8bn; GlaxoSmithKline has 57 and is capitalised at £75bn which, even accounting for GSK's existing drugs, makes European biotech look a bargain. The trouble is the biotech pipeline is scattered among dozens of cash-strapped tiddlers.

Successful European companies have had one big success and used the proceeds to bulk up by buying rivals. Shire Pharmaceuticals, one such, is now a FTSE 100 company with some impressive growth prospects. At 489.5p, its shares look cheap in the wake of its débâcle over the ousting of the chief executive Rolf Stahel.

Oxford GlycoSciences' position is particularly fascinating. Its lead drug should get the green light for launch within weeks, but it has no others close. It hopes to buy a rival and spend its cash pile to develop the acquired drugs, a tactic that makes it one of the most likely long-term winners. The trouble is the purchase will be in shares, which are only going south until it is done. The further they fall, the less attractive a deal will be. Will shareholders do the long-term thing and back a deal? Don't bet on it.

As WestLB points out, the most significant share price booster in biotech continues to be a licensing deal, which brings cash in from a bigger pharmaceutical company in return for rights to market a biotech drug. Attractive companies which could do such deals soon include Protherics, Alizyme, GW Pharmaceuticals and Vernalis. All four look to be worth a punt.

Investec still not cheap enough

Timing is everything in the business of investing, and Investec's timing has been poor. The financial services conglomerate raised money in London at the pit of the bear market in July, when it shifted its primary listing here from its native South Africa. It has also started reporting its results in sterling after the rand, in which it makes most of its profits, has collapsed in value. And it bought up a string of international assets during the stock market boom only to see them suffer.

Things are so dire outside the homeland that 73 per cent of the group's operating profit came from South Africa in the six months to 30 September, despite all Investec's efforts to rebalance the group away from that unfashionable and risky "emerging market". Its investment banking division is now operating at a loss as deals in the UK and US markets have been few and far between. The company says there has been a pick-up in recent weeks (it worked on the Carphone Warehouse acquisition of Opal Telecom and is advising on the auction of Fitness First), but things are going to stay difficult for some time.

The bear market has slashed profits from asset management, and the only real bright spot has been private client banking (lending cash to the wealthy), which has been boosted by low interest rates.

With the rand some 36 per cent lower in the interim period than last year, group pre-tax profits plunged 61 per cent to £15.6m. It is not clear that this represents the nadir and the shares at 832.5p, justifiably at a discount to developed market banks, are not cheap enough to chase.

The heat's still on at Enodis

A huge restructuring effort in the past 12 months may have seen the cooker maker Enodis jump out of the frying pan, but a prolonged downturn in the markets it supplies means it is still in the fire.

The group has made significant progress in reshaping itself and slashing debt, but guarded comments about the outlook for 2003 suggest question marks still surround its future performance. The bulk of the group's business – selling ovens, fridges, grills, fryers and freezer cabinets to restaurants, hotels and supermarkets – comes from the US where trading has been very tough. That even McDonald's, a big Enodis customer, finds it hard to sell burgers, illustrates why the market for new cookers has cooled.

Fundamentally, Enodis is in a good market. Changing lifestyles mean more people grab food on the run. The big unknown is how much longer Enodis's customers will continue to defer spending on items such as new ovens.

After a string of asset disposals, which helped it to slash debt to £186m, Enodis reported a 40 per cent fall in pre-tax profits before goodwill and exceptional items to £38m. But interest payments are still only 2.5 times covered, so there is no room for the problems such as it is suffering in a division which supplies supermarkets with display cabinets. The share price leap of 10p to 55p on yesterday's results was overcooked. Avoid.

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