Although pharma and biotech stocks are facing challenges in the form of increasing focus on the high prices of drugs, a changing competitive scenario and mixed results, the sector’s fundamentals remain strong -- innovation, mergers and acquisitions (M&As), product approvals and positive data flow should act as catalysts.

M&As to Pick Pace?

Expectations are high that the pharma sector will witness an increase in M&As as the year progresses -- potential tax reform and cash repatriation are expected to lead to a boost in this area. While so far, not too many deals have been announced, we could see several M&A agreements being announced in the coming quarters though companies are wary of bidding wars leading to over-priced deals.

Big players like Sanofi have expressed an interest in pursuing M&A deals. Allergan has also been very active on the acquisition and deal-making front. Industry bellwether Johnson & Johnson recently acquired Actelion for approximately $30 billion. While some of these companies are looking to replace sales of blockbuster products that are facing loss of patent exclusivity, others are looking to build their pipelines both through acquisitions as well as licensing agreements.

Companies with innovative technologies and pipelines are highly sought after. Niche disease areas like nonalcoholic steatohepatitis (NASH), immuno-oncology and multiple sclerosis are in demand. Treatments for orphan diseases are also much sought after with quite a few deals being signed in these areas.

Innovative Pipelines & Catalyst Rich 2017

Pharma and biotech companies continue to work on bringing innovative new treatments to market, and there could be significant catalysts in the coming quarters in the form of important new product approvals as well as major data read-outs especially in important therapeutic areas like immuno-oncology, Alzheimer’s, hepatitis C virus (HCV), central nervous system disorders, and immunology/inflammation.

Among these, immuno-oncology has been attracting a lot of interest as these therapies have the potential to change the treatment paradigm for cancer -- they basically use the natural capability of the patient's own immune system to fight the disease. Major players in this field include Bristol-Myers (BMY Quick QuoteBMY - Free Report) , Novartis, AstraZeneca, Merck (MRK Quick QuoteMRK - Free Report) and Roche.

Deals targeting immuno-oncology are being inked by companies like Pfizer (PFE Quick QuotePFE - Free Report) , Merck KGaA, Bristol-Myers, AstraZeneca and Incyte. Companies like Kite are also advancing in this area. Interest in PARP inhibitors has also increased considerably as they could well be the next major class of therapeutics in oncology.

According to IMSQuintiles, 68 new cancer drugs were approved for 22 indications from 2011 to 2016 while worldwide costs for cancer therapeutics and supportive care drugs shot up from $91 billion in 2012 to $113 billion in 2016. More than 600 molecules are in late stage development with the majority being targeted therapy.

New Product Sales Should Ramp Up

Sales of products that gained approval over the last two years as well as line extensions should ramp up and boost growth. New products with blockbuster potential include Amgen’s PCSK9 inhibitor, Repatha, Novartis’ psoriasis treatment, Cosentyx, and Pfizer’s cancer treatment, Ibrance. Cancer treatments like Kyprolis, Keytruda, and Imbruvica should also bring in more sales thanks to label expansions.

The FDA approved 22 new drugs in 2016 including Zinplava (c. difficile infection), Lartruvo (soft tissue carcinoma), Exondys 51 (Duchenne muscular dystrophy), Epclusa (HCV), Ocaliva (rare, chronic liver disease), Zinbryta (multiple sclerosis), Tecentriq (urothelial cancer), Venclexta (chronic lymphocytic leukemia in patients with a specific chromosomal abnormality), Taltz (moderate-to-severe plaque psoriasis), Cinqair (severe asthma) and Zepatier (HCV) among others. The agency also expanded the label of cancer drugs like Kyprolis, Imbruvica and Xalkori.

Faster Drug Approval Process

At a meeting with pharma majors earlier this year, President Trump spoke about speeding up the FDA approval process. Last year, the number of new drug approvals slipped to 22, well below the 45 approvals in 2015 and 41 in 2014. The President said that the FDA will be streamlined and the drug approval process will be much faster. The recently signed 21st Century Cures Act is a step in this direction.

With the passing of this Act, expectations are that there will be more innovation in the sector and, maybe, a surge in new drug approvals. Some of the key drugs currently under FDA review with decisions expected in the next few months include Celgene’s enasidenib (relapsed or refractory acute myeloid leukemia), Puma’s neratinib (breast cancer), Kite’s axicabtagene ciloleucel (cancer) and Teva’s SD-809 (tardive dyskinesia) among others.

Meanwhile, the agency is working on streamlining the development process for drugs for rare diseases as well as for targeted cancer therapies. The FDA is also working on clearing up a backlog of orphan drug applications.

So far in 2017, the FDA has given its nod to 23 new drugs, already surpassing last year’s total tally of 22. Among this year’s approvals, drugs like Kevzara (adult rheumatoid arthritis) and Dupixent (eczema) have blockbuster potential.

According to the IMSQuintiles report, the late-phase R&D pipeline for the industry indicates that there should be about 40-45 new brand launches every year through 2021.

Stock Picks

Although the sector may face some volatility due to the drug pricing issue, pipeline success in innovative and important therapeutic areas, cost-cutting, share buybacks, new products, increased pipeline visibility and appropriate utilization of cash should help restore investor confidence in this sector.

Here are a few stocks that look well-positioned and carry a favorable Zacks Rank -- #1 (Strong Buy) or #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Sanofi (SNY): French pharma giant, Sanofi, has a strong presence in several markets including diabetes, cardiovascular, rare disorders, vaccines and consumer healthcare. The company, which had recorded a decline in share price last year, has outperformed the Zacks-categorized Large Cap Pharmaceuticals industry this year with shares gaining 21.9% YTD.

Although Sanofi’s diabetes segment will remain under pressure in 2017, the company got a boost this year with the FDA approval of two drugs with blockbuster potential -- eczema treatment, Dupixent, and rheumatoid arthritis treatment, Kevzara. As the pipeline continues to deliver and new product sales ramp up, this Zacks Rank #2 stock could well be poised for a turnaround.

Regeneron Pharmaceuticals, Inc. (REGN): Tarrytown, NY-based Regeneron’s key growth driver eye drug, Eylea, continues to perform well. The company has been working on diversifying its portfolio and gained FDA approval for two drugs this year -- Dupixent (moderate-to-severe atopic dermatitis) and Kevzara (moderately to severely active rheumatoid arthritis). Both have blockbuster potential with Dupixent already off to a strong start. The company also has a strong pipeline. Regeneron, a Zacks Rank #1 stock, has outperformed the Zacks-categorized Medical-Biomedical/Genetics industry with shares gaining 36.8% YTD. Estimated earnings growth for the current year is 27.4%.

Sangamo Therapeutics, Inc. (SGMO): Richmond, CA-based Sangamo is a clinical stage company focused on translating ground-breaking science into genomic therapies based on its platform technologies in genome editing, gene therapy, gene regulation and cell therapy. The company got a shot in the arm recently with Pfizer signing a deal for the development and commercialization of gene therapy programs for hemophilia A. This deal bodes well for the long-term prospects of the company. Shares of this Zacks Rank #2 stock are up a whopping 185.3% YTD.

All said and done, the pharma sector’s fundamentals remain strong -- robust pipelines, innovative treatments, impressive results, growing demand for drugs especially for rare-to-treat diseases, an aging population and increased health care spending should support growth. To know more about this sector, check out our latest Pharma Industry Outlook.

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