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Bull of the Day

The biotech bull market is far from over due to several secular and macro drivers like an aging population, cash-rich "big pharma" facing patent cliffs forcing them to buy new drugs, and the incredible success of small companies doing innovative disease R&D.

One such small company making headlines lately is Epizyme (EPZM - Snapshot Report), a clinical stage biopharmaceutical company creating personalized therapeutics for patients with genetically defined cancers. Epizyme has built a proprietary product platform that the company uses to create small molecule inhibitors of a 96-member class of enzymes known as histone methyltransferases, or HMTs.

HMTs are part of the system of gene regulation, referred to as epigenetics, that controls gene expression. Genetic alterations can result in changes to the activity of HMTs, making them oncogenic (cancer-causing). By focusing on the genetic drivers of cancers, Epizyme's targeted science seeks to match the right medicines with the right patients for a personalized approach to cancer treatment.

Phase I Data Encouraging

Writing for TheStreet.com this week, David Sobek summed up the pre-clinical data and early clinical observations from an ongoing Phase I trial...

"Epizyme reported the first clinical data on its blood cancer pipeline candidate EPZ-6438 at the ASH Lymphoma Biology Conference last week. The drug is designed to block a specific enzyme, EZH2, which when mutated, is involved in development of certain cancers, including forms of non-Hodgkins lymphoma (NHL).

"The first look at EPZ-6438 came from an early-stage (phase I) study, but was encouraging. Two of the four NHL patients reported a partial tumor response, a third patient had stable disease. The responses came from relatively low doses of EPZ-6438 and the safety profile was clean enough to allow Epizyme to continue the study using higher doses of the drug."

In response to this data and a surprise 13% earnings beat last week (reported a loss of only $0.40 vs consensus expectations of $0.46), Wedbush analyst issued an updated report where they reiterated their OUTPERFORM rating on EPZM shares and their $52 price target.

"Our PT of $52 per share is derived from applying 8x and 15x multiples to our 2019 estimated sales and royalty revenues, respectively, discounted by 25% annually back to YE:14."

No Profits in Sight

As with many clinical stage biotech companies, positive earnings are a long ways off for Epizyme. In fact, the company is expected to burn more cash next year than this year. Here are the detailed EPS tables that show how the two covering analysts have been adjusting earnings over the past 90 days...

Speaking of cash to burn, the company had $232 million at the end of the recent quarter and provided guidance of $170 million at year end, sufficient to last until at least mid- 2016. Wedbush analysts noted, "The cash runway does not take into account any additional milestone payments from partners, and we note that we expect EPZM to receive at least $10M in milestones (from Eisai for the start of the Phase II EPZ-6438 trials) for the remainder of 2014."

Eisai is a Japanese pharmaceutical company. Partnerships with large biopharma companies are essential to emerging biotechs who need much financial support for heavy R&D in the early stages.

In his recent article, Sobek indicates that "Outside of EPZ-6438, Epizyme is developing a drug with Celgene (CELG - Analyst Report) and has three other drug candidates still in preclinical testing which are part of a partnership with GlaxoSmithKline."

High Risk, High Reward

Currently there are so many Zacks #1 Rank (Strong Buy) and #2 Rank (Buy) stocks in the Biomedical/Genetic industry group that it ranks in the top 30% of all industries. This is quite a feat for a group with 180 companies in it and it is driven by the secular and macro trends I mentioned at the top of this article.

EPZM first became a Zacks #1 Rank on July 9 when the stock was trading around $30. It subsequently shot up to $40 after their recent earnings surprise. As with all emerging biotechs, there is significant risk around clinical trials and FDA events on the long road to profitability.

As these companies advance through Phase II trials, the possibilities increase for wild price swings, often without justification from a change in the earnings outlook but merely from speculation about a take-over by a bigger biopharma franchise.

But checking the estimate tables above periodically can keep you abreast of the earnings trends where analysts suddenly see significant upside in sales projections, which might make these stocks an attractive opportunity for the "bio speculator" part of your portfolio.

Another element I like to track is institutional buying. In Q2, the biggest buyer was QVT Financial adding 531,900 shares to boost their stake to over 1 million. They were followed by T. Rowe Price starting a new position with 524,531 shares. This not heavy accumulation but it is something to keep an eye on.

Kevin Cook is a Senior Stock Strategist for Zacks where he runs the Follow The Money portfolio.

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