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    The pharmaceutical, biotech and life science sector has been one of the sharemarket's star performers.

    As bird flu fears swept Europe and North America during 2005 and 2006, a small Melbourne biotechnology company was abruptly thrust into the spotlight. The firm was Biota Holdings, developer of the anti-flu drug Relenza, one of only two anti-virals that had proved effective in combating the lethal H5N1 strain of the bird flu (the other was Roche Holding's Tamiflu).

    Relenza, described by immunologist Sir Gustav Nossal as "one of the greatest Australian research inventions", is in demand around the world. The US Government plans a $2 billion pandemic anti-viral stockpile, with Relenza expected to be responsible for up to 20 per cent of this. Last November, Britain's famed Royal Society and the Academy of Medical Sciences, in a joint report, called on the British government also to begin stockpiling the drug.

    It is an Australian success story, another example of how this country so often punches above its weight in global medical research. Unfortunately, the Relenza story also illustrates why many investors shy away from biotech and pharmaceutical shares.

    In August 2005, investors caught a whiff of Relenza's potential and Biota's shares began to soar. From about 50 cents at the beginning of the month, they touched $2.75 in mid-October before falling as low as $1.35 a month later. Occasional double-digit percentage price rises or falls within a single day were a phenomenon.

    Meanwhile, Biota Holdings has not reported a profit since its June 2000 financial year, it does not pay dividends and it is engaged in litigation against Relenza's distributor, GlaxoSmithKline, for allegedly not promoting the drug vigorously. The case will not go to trial until next year and the outcome is, of course, uncertain.

    The result of all this is many private share buyers cast their eyes over companies such as Biota, and even over market heavyweights such as CSL, and decide biotech and pharmaceutical stocks are best left to investment professionals or short-term traders. That is a shame, for the stocks have been stellar long-term performers.

    In January, Commsec released a market analysis revealing that in the 21 years to 2006, the pharmaceuticals, biotechnology and life sciences sector was the best performing of the 24 Australian Stock Exchange industry groups, with a remarkable average annual gain of 25.5 per cent (capital gain plus dividends), compared with 14.1 per cent for the broader market. Second was the media industry group with a 23.8 per cent return, followed by retailing with 21.8 per cent.

    Craig James, chief equities economist for Commsec, says much of the performance came from the outstanding accomplishments of pharmaceuticals and blood products company CSL, formerly Commonwealth Serum Laboratories, which was floated in 1994 at $2.40 a share and was trading at about $65 by the end of last year. However, he notes the sector had been outperforming the rest of the market even before CSL came along. Despite common belief, the sector is not more volatile than others.

    "Biotech in Australia consists of a large number of small companies," he says. "Not all will do well. But companies that have found a niche, exploit that and live through the early stages of ramping up the company have gone from strength to strength. Those that are successful can be very successful."

    Other trends are at work, too. An ageing population is an obvious and often-cited factor. The percentage of the population aged over 65 rose from 8.3 per cent in 1971 to 12.4 per cent in 2001 and is forecast to jump to 21.3 per cent by 2031. These people are expected to be huge consumers of pharmaceutical products and the drug companies are eagerly formulating lots of new ones to keep them happy.

    Another compelling reason for the sector's buoyancy is explained by Gavin Duffy, senior analyst with E.L. & C. Baillieu. "Healthcare in Australia is underwritten by government funding and the big health insurers," he says. "Sometimes the big funds put pressure on costs but at the end of the day whatever's agreed is paid out. You don't get a bad debt element. Producing drugs is a guaranteed income."

    He says in recent years there has been a degree of rationalisation within the industry, reducing competition. "Look at Sigma," he says. "It dominates the domestic market. The Federal Government may put pressure on it under the Pharmaceuticals Benefits Scheme but it covers the field from manufacture to wholesale to retail. It has opportunities to preserve margins."

    Nevertheless, investors need to be aware of the drawbacks. This is a diminutive sector that represents less than 1.4 per cent of the market. (By comparison, it is more than 7 per cent in both Britain and the US.)

    Eighty seven pharmaceuticals and biotechnology companies are listed on the ASX but most are tiny, with products that are still yet to become a commercial reality.

    Only three make it into the S&P/ASX 200 index of the 200 largest companies: CSL, Mayne Pharma and Sigma (and of these Mayne Pharma is about to be delisted following its acquisition by US company Hospira). A further 19 are in the S&P/ASX All Ordinaries index of the 500 largest stocks.

    Those companies that have any earnings at all tend to be on high price-earnings ratios. Dividends, where they are paid, are usually small. Some of the stocks are barely liquid. And they are volatile.

    Commsec says over the long term they are no more volatile than other industry groups but short-term price movements can cause heart-in the-mouth moments for even seasoned investors.

    David Blake is co-editor of the Bioshares weekly stock report and has been covering the sector since 1998.

    "A lot of hype surrounds the sector and you have to get away from this," he says. "You have to focus on the business. You have to look on each company as a business rather than as a cure for this or that. Don't fall in love with an exciting product. Do your homework. Ask questions. Learn all you can."

    He concedes novice investors might be better advised to concentrate first on another sector, where the inevitable mistakes could be less costly. "Not everyone understands market behaviour. It catches people out. For example, you should be ready to take profits if a stock runs up too much. A good company with good products can still see its share price driven up to a point where it is too high. So a stock might fall 30 per cent for no apparent reason."

    But his optimism remains high. "When you get through some of the negatives you discover that it is a very attractive sector," he says. "There is phenomenal demand growing for these products. We have barely scratched the surface of treating people's health-care problems."

    Biotech stocks with a promising future
    CSL Gavin Duffy at E.L. & C. Baillieu describes the company as "a world leader that will just keep on growing". It is already a global leader in blood products and flu vaccines and some analysts say its Gardasil cervical cancer vaccine could earn billions.

    Peptech (PTD) David Blake of Bioshares recommends smaller stocks including Peptech, Biota and Sirtex Medical. Peptech, a leading developer of antibody drugs, is already profitable. It has no debt and good cash holdings, as well as a strong income stream from royalties and licence fees.

    Biota Holdings (BTA) Although Biota is not in profit it does have strong cash holdings. Its Relenza anti-flu drug has huge potential and the company has some promising drugs to treat influenza, respiratory problems and hepatitis in the pipeline.

    Sirtex Medical (SRX) A world leader in liver cancer drugs, with fast-growing sales and profits. Hunter Hall Investment Management has taken a large stake in the company.

    Martin Roth is the author of Top Stocks 2007 (John Wiley & Sons), $29.95. Herald and Age subscribers can buy this book for $26.95. Call 1300 656 059 or go to www.smh.com.au/store or www.theage.com.au/store.
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    First published: January 24, 2007

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    1169330826278-brisbanetimes.com.auhttp://brisbanetimes.com.au/news/investment/a-wild-ride-that-can-pay-off/2007/01/22/1169330826278.htmlbrisbanetimes.com.auThe Sydney Morning Herald & The Age2007-01-24A wild ride that can pay offMartin RothBusinessMoneyInvestmenthttp://brisbanetimes.com.au/ffximage/2007/01/24/JTROLLERCOASTER_wideweb__430x276,0.jpg430276http://brisbanetimes.com.au/ffximage/2007/01/24/JTROLLERCOASTER_th.jpg6040http://brisbanetimes.com.au/ffximage/2007/01/24/JTROLLERCOASTER_syndicated__430x276.jpg430276http://brisbanetimes.com.au/media/2007/01/24/1169594332779.htmlimage/graphics-popout
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