Undervalued Stocks in Biotech Worth Buying

Source: U.S. Food and Drug Administration via Facebook.

Among individual sectors, few have outperformed the broader market averages more since the Great Recession than biotechnology.

The move higher in biotech stocks shouldn't really come as a huge surprise. When the U.S. economy is on track and unemployment levels are declining, consumers tend to have more disposable income to invest, and investors tend to be willing to take more risks.

The biotech sector certainly fits a high-growth, riskier profile for investors, since nearly 90% of companies are losing money on a trailing 12-month basis and most companies' valuations are based on the peak annual sales potential of their lead drug. But if an experimental drug proves its worth in clinical studies, the returns can be almost roulette-like, with the potential for three- and four-digit percentage gains.

Of course, one of the downsides of an extended bull market is that it can leave value investors with little to choose from, especially in high-growth sectors such as biotech. The term "bubble" has been thrown around when discussing biotech stocks, and I haven't exactly shied away from acknowledging the possibility that certain segments of the group, such as clinical-stage biotech companies, may indeed be in bubble territory.

Cheap buys in biotech nowThere are still a select few companies in the industry that could arguably be called "undervalued." Today, we'll take a look at three biotech stocks that I believe are undervalued and worth buying.

Gilead Sciences I know I've said it before and here I'm saying it again for perhaps the 50th time: Gilead Sciences is an underappreciated and undervalued biotech stock.

Source: Gilead Sciences.

Gilead is the company behind Sovaldi and Harvoni, two next-generation oral hepatitis C medicines that act as an effective cure for the disease. A little over four years ago patients had to undergo up to 48 weeks of treatment, and were cured only around half of the time. Sovaldi and Harvoni delivered a cure rate north of 90% in nearly all clinical studies, and best of all, neither needs to be taken with IV interferon, which can cause unpleasant flu-like symptoms in patients. Harvoni is even one step better than Sovaldi in that it doesn't need to be taken with side effect-laden ribavirin either. In its latest quarter, the Gilead HCV duo accounted for $4.5 billion of the company's nearly $7.6 billion in sales.

But there's lots of hope for Gilead beyond just HCV. Stribild, its four-in-one HIV/AIDS drug, continues to gain momentum and is on pace for $1.4 billion in annual projected sales based on its Q1 sales totals. There are 35 million people worldwide with AIDS according to the World Health Organization, so this is a global and multi-decade opportunity for Gilead.

Let's not also forget that Gilead Sciences is at the forefront of hepatitis B and nonalcoholic steatohepatitis, or NASH, research. Hepatitis B affects some 240 million people worldwide according to the WHO, while NASH is a disease that can affect anywhere from 3 million to 6 million people in the U.S. in its most serious form.

With ample pipeline opportunities, a long tail growth picture, and a PEG ratio below one, Gilead remains a drastically undervalued biotech stock in my view.

Celgene I believe Celgene, another of the biotech blue chip stocks, also offers both value- and growth-seeking investors an opportunity to tack on substantial profits over the long run.

Celgene has a number of ways to grow, and it's truly a triple threat.

It has internal growth capabilities, as demonstrated by its recent approval of anti-inflammatory drug Otezla as a treatment for psoriatic arthritis and psoriasis. In fact, much of Celgene's internal growth is going to come from the label expansion of its three key products: Otezla and cancer drugs Revlimid and Abraxane. Otezla, for instance, has six additional indications it's being tested in, while Revlimid could expand to eight new indications before the end of the decade.

Second, Celgene has roughly 30 ongoing collaborations ranging from cancer to inflammation and immunology. Understanding that it can't do everything internally, Celgene has been more than willing to partner up with smaller biotech stocks in an effort to advance drugs that work via new pathways.

Source: Celgene.

One good example would be its deal with OncoMed Pharmaceuticals , which could be worth over $3 billion in maximum milestone payments if OncoMed's anti-cancer stem cell (CSC) drugs work as expected. Anti-CSCs aim to destroy cells that are generally resistant to chemotherapy and are believed to be the source of cancer metastasis. This pathway could be a source of incredible profits and increased quality of life for patients if proven successful.

Lastly, Celenge can buy growth if need be. In 2010 it acquired Abraxis BioScience and cancer drug Abraxane. With newer label indications in pancreatic cancer and first-line non-small cell lung cancer, and with the potential for an approval in first-line, triple-negative metastatic breast cancer, Abraxane is expected to grow into a $1.5 billion to $2 billion per year drug by 2017. In 2009, before Celgene acquired it, Abraxane generated just $315 million in annual sales.

These multiple pathways to growth give Celgene a complete set of tools that few biotech companies possess.

ANI Pharmaceuticals Finally, from the peaks of biotech megacap stocks all the way down into small-cap country, I'd suggest that investors seeking undervalued stocks in biotech worth buying give ANI Pharmaceuticals a closer look.

Like the megacaps above, ANI Pharmaceuticals brings its own unique qualities to the table for investors. In this case, it's the opportunity to invest in a company with both branded and generic drug offerings. Branded drugs are attractive because of their superior margins and exceptional pricing power. The downside, of course, to branded therapies is their finite period of patent protection. This is where generic drugs come into play.

Source: U.S. Food and Drug Administration.

Generics may offer considerably lower margins than branded drugs, but their competitive price point can boost volume and more than make up for the smaller margins. Additionally, focusing on generic drugs allows for a seemingly endless pipeline of drug opportunities. Generic drugs often succeed in being profitable for a drug manufacturer because generic drugmakers can pick and choose which therapies to go after, ensuring they don't launch a generic drug into a money-losing or highly competitive indication.

In ANI Pharmaceuticals' most recent quarter it delivered a 72% increase in total sales to $18.8 million, with revenue from branded pharmaceuticals more than quintupling year-over-year to $4.3 million due to the acquisition of Vancocin and Lithobid last year. Generic drug revenue rose by a not-so-paltry 52% to $12.3 million due to acquisitions and organic growth. Higher sales of branded products also caused ANI's cost of sales to plummet 9% to 15%.

Currently holding a generic portfolio of 46 drugs with a market potential of $3 billion, and with Wall Street projecting double-digit growth for ANI Pharmaceuticals throughout the remainder of the decade, I'd opine its forward P/E of 13 places this stock in undervalued territory.

The article Undervalued Stocks in Biotech Worth Buying originally appeared on Fool.com.

Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen nameTrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.The Motley Fool owns shares of and recommends Gilead Sciences. It also recommends Celgene. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.