If you were a biotech bull in 2003, 2004, and 2005 your favorite large cap biotech stock was probably Genentech (NYSE: DNA).  If you traded Genentech in 2006 and 2007, remaining a bull was one painful lesson.  In fact, shares very briefly hit $100 in December 2005 and they have recently traded as low as $65.60 this month.  Shares are down today by almost 1.5% at $70.45 but so far that $70 handle is holding.

Traditionally Genentech has remained a biotech that beats earnings expectations, although that number was only a "barely beat target" last quarter.  The problem that has persisted isn’t the actual growth as much as it is analysts and investors keying in on specific drug estimates not being a blowout on all of its labels.  Revenues were only $6.6 Billion for all of 2005.  The cancer franchise is massive there, yet there always seems to be a general disappointment in one drug or another  (Avastin, Rituxan, Herceptin, Lucentis, Xolair, Tarceva, Nutropin, Activase, Raptiva). 

What we are looking at now internally is the forward valuations, which we feel are achievable in light of the company having a multi-year plan in place.  With estimates showing Fiscal DEC-2008 at $3.37 EPS on revenues of $13 Billion, we have a forward P/E ratio of just under 21 for 2008, and a price to sales ratio (based on a $74 Billion market cap) of 5.69.  For what we believe is still the key leader in its cancer franchise with what is still believed to be a large drug candidate pipeline, we can easily live with these numbers.

Trying to use the "Value Investing" approach to biotech is not always applicable.  We’d merely point you to the woes at Amgen (NASDAQ:AMGN) and Biogen-Idec (NASDAQ:BIIB).  The forward P/E ratios and the sales multiples won’t matter at all if a blockbuster drug franchise comes under target.  While biotechs have been shielded in the past, it is open season on drugs during an election year whether you are a biotech company or just an old stodgy drug company.

We still believe that investors want to own stocks.  And as the economy slows into a recession we think investors will want to own stocks that may have implied safety nets in them.  Many of the other defensive stocks had been showing bubbly valuations just last week, and that doesn’t appear to be the case here.  Now we just have to see if the focus will turn back to the overall performance of the company as a whole.  If the focus will stay on each and every drug at the company then it’s hard to imagine that there won’t be any areas that traders can say were under their investment models.

Wall Street still has an average price target north of $82 per share over the next year and there is still a high target north of $100 out there.  The chart is still one that is at-risk longer-term, but on a short-term it has recovered.  If the street takes a disappointing reaction again we could see that going back to that $65.00 handle.  If there is some horrible unexpected news then who knows where they will find support as the year lows from December and January are roughly 30-month lows.  If options are any accurate tool today it appears that options traders are only looking at an expected price move of up to $2.50 or so in either direction.

As Genentech is the bogey in biotech now, it can affect the entire sector.  It also has partnerships with Novartis (NVS), Biogen-Idec (BIIB), OSI Pharma (OSIP), and others.  It is also still majority-owned by Roche, so the earnings implications and drug comments from Genentech can be far reaching and not just in the U.S.

Genentech is key to one ETF as it represents some 36% of the Biotech HOLDRs (AMEX:BBH). 

Jon C. Ogg
January 14, 2008