Small-Cap Biotech Stocks Play Catch Up With Industry Leaders

(Bloomberg) -- Small-cap biotech stocks are lagging this year with the spotlight squarely on their larger rivals who have been in a position to supply the world with Covid-19 shots and treatments.

Pfizer Inc. reached record highs on news last week that the White House would issue new guidance for booster shots, while its vaccine partner BioNTech SE and Moderna Inc., also making virus inoculations, have delivered triple-digit gains this year. Small-cap biotech stocks by contrast are down for the year, based on various measures, but analysts and investors expect this cohort of the sector will soon play catch up.  

“It’s a question of when it recovers,” Jason Butler, an analyst at JMP Securities, said in an interview. “Not if it recovers.”

For one, gains for biotech stocks have historically been led by the larger companies with the rest of the group following. And potential catalysts for small-caps exist ahead including positive results in clinical trials and clarity out of Washington on market-moving issues like mergers and acquisitions and drug pricing regulation.

The market-weighted Nasdaq Biotech Index is up 8.7% year to date due largely to Moderna, while the SPDR S&P Biotech ETF, which tracks the equal-weighted S&P Biotechnology Select Industry Index and is seen as more of a proxy for small caps, has declined 13% year-to-date. In the Russell 2000, the health-care sector is the only one in the red for the year with an 8.7% decline.

The recent underperformance comes amid heightened competition for investors’ dollars, according to Oppeinheimer analyst Hartaj Singh. Those who focus on biotechs have had a healthy crop of initial public offerings, splitting their attention with a slew of existing biotechs. July marked a record month for the number of these deals in the U.S., according to data compiled by Bloomberg.

Generalists have turned to the safer bets, especially large players working on coronavirus therapies. Some investors see an “easy opportunity to make money off of companies like BioNTech and Moderna,” Patrick Nosker, director of research for Affinity Asset Advisors, said in an interview.  

Still, overall gaps between small and large caps historically don’t last long. JMP’s Butler said the successes of the large companies tend to signal that smaller ones are soon to follow suit. During downturns in 2015 and at the end of 2018, larger-cap biotechs led the recovery, followed closely by their smaller counterparts, he said.

“Corrections of this size are usually followed by recoveries,” added Roderick Wong, chief investment officer of RTW Investments. “At a minimum we would expect the gap in performance to narrow between small-cap biotech and others.”

Closing the gap could hinge on public policy regarding consolidation and drug pricing as well as the appointment of a permanent Food and Drug Administration commissioner, according to Nosker. Uncertainty on these issues has weighed on the market this year. Product approvals or positive clinical data announcements, meanwhile, can turbo charge a biotech stock.

Shares of Cassava Sciences Inc., while off the highs, have skyrocketed nearly 1,500% this year on positive trial results for its Alzheimer’s drug and the ripple effects of the approval of the treatment from its larger rival Biogen Inc. Biogen’s shares are up 40%, another standout among big biotechs.

Butler is optimistic about Syros Pharmaceuticals Inc., which is set to release data pertaining to a cancer treatment later this year. He also expects Karuna Therapeutic Inc. to advance off of its drug aimed at combating schizophrenia.

Some biotechs pushed data readouts due to Covid-related delays, according to Tom Brakel, a senior portfolio manager at Federated Hermes. These delays can weigh heavily on the shares of small companies that don’t generate revenue from existing products on the market. For Brakel, the potential for positive clinical trial results in the coming months coupled with the current low valuations creates a buying opportunity.

“This is like being a kid in a candy store,” he said.

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