Biotech was one of the best-performing industries from 2012 to 2022. The iShares Biotechnology ETF and the SPDR S&P Biotech ETF markedly outperformed the S&P 500 over this period, thanks to an innovation boom spearheaded by the human genome project and ultralow interest rates.
However, in 2022, a pivotal moment occurred when the Federal Reserve shifted its stance on interest rates. As a result of the central bank’s decision to ratchet up rates, biotech stocks experienced a sharp decline almost across the board, plunging the industry into a bear market.
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With the Federal Reserve planning to reduce rates later this year, however, biotech may be poised to reclaim its position as a top area for wealth creation. One stock that could benefit from a shift in investor sentiment is Madrigal Pharmaceuticals (NASDAQ: MDGL).
Madrigal’s shares have modestly outperformed the S&P 500 this year, but its stock still screens as significantly undervalued. Here’s why aggressive investors may want to start accumulating shares of the liver-disease specialist before the central bank starts cutting rates.
Madrigal Pharmaceuticals recently achieved a significant milestone with the Food and Drug Administration’s (FDA’s) accelerated approval of Rezdiffra, the first drug approved for metabolic dysfunction-associated steatohepatitis (MASH) — a condition closely linked to the global obesity epidemic.
This landmark approval puts Madrigal in a powerful position within one of the largest untapped pharmaceutical markets in the world. Specifically, Wall Street analysts project Rezdiffra’s 2030 sales at a robust $2.6 billion and its peak sales at a noteworthy $5.5 billion.
Despite the lofty sales targets set for Rezdiffra, investors remain somewhat skeptical. To illustrate, Madrigal’s shares are currently trading at under two times Wall Street’s 2030 revenue forecast.
This is in stark contrast to prevailing industry norms. Revenue-generating biotechs, on average, trade at no less than three times their forward-looking sales estimates. The primary reason for this trend is that many commercial-stage biotechs represent potential buyout candidates.
So, why is Madrigal’s stock trading at a significant discount relative to Rezdiffra’s commercial potential? The emergence of next-generation weight-loss drugs could potentially limit the commercial opportunity for MASH-specific therapies. This competitive threat seems to be impacting Madrigal’s attractiveness as a potential buyout candidate.
Is Madrigal stock a buy? The bottom line is that the biotech’s shares sport a very favorable risk-to-reward ratio. A well-documented medical need exists for an effective MASH therapy; no direct competition exists for Rezdiffra; and Madrigal’s shares trade below industry norms. Moreover, Rezdiffra shouldn’t have much trouble meeting analysts’ $2.6 billion 2030 sales projection despite the potential impact of next-generation weight-loss drugs on the incidence rate of MASH.
Three key factors lend credence to this last point:
The MASH market isn’t solely driven by obesity.
Weight-loss drugs alone are unlikely to provide any significant benefit to patients who have severe liver scarring.
Over eight-million Americans and an additional 92 million adults globally are estimated to have liver damage due to this condition.
MASH should thus turn out to be an exceptionally large market capable of supporting multiple blockbuster drugs. Consequently, this mid-cap biotech stock screens as a no-brainer buy for growth investors with a moderate tolerance for risk.
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George Budwell has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends SPDR Series Trust-SPDR S&P Biotech ETF. The Motley Fool has a disclosure policy.
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