While increases in the interest rate from the Federal Reserve are usually bad for biotech, the sector at this moment is poised to withstand the blow, according to analysts, though earlier stage companies may be left in the lurch.
The Federal Reserve made a move yesterday that is universally considered bad for biotech—raising the federal funds rate by a quarter percentage point in the face of rapidly expanding economic activity.
But the biotech sector was standing on strong footing heading into the rate hike, leaving analysts from BMO Capital Markets confident that the central bank’s move will not have the strong impact that previous interest rate increases have.
Driving biotech is a return of M&A as larger pharmaceutical companies face loss of exclusivity for key assets and a need for differentiated assets from smaller companies, BMO wrote on Wednesday prior to the Fed’s action.
“We believe this can persist, but higher rates should increase stock selection rather than automatically derail the sector,” the analyst said.
An increase in the fed rate makes capital more expensive. Biotech is a capital-intensive industry that requires long bets before a payoff.
Indeed, when the Fed announced the rate decision at 2 p.m. ET on Wednesday, the S&P Biotech ETX (XBI), a biotech exchange used as a measure of the sector’s performance, fell sharply. The fund has dropped over 3% in the past five days. But year to date, the XBI is up more than 26% and is sitting at $155 a share.
“Recent XBI outperformance (+26% YTD) suggests investors are becoming increasingly comfortable with a higher-rate environment,” BMO wrote.
“Rather than selling Biotech broadly as rates move higher, investors appear more willing to differentiate among companies based on clinical catalysts, balance-sheet strength, and strategic value,” the analysts continued. “This does not mean rates no longer matter, but it does suggest they are becoming less important than company-specific fundamentals and improving sector sentiment.”
With the rate hike, BMO predicts that preference will continue to shift toward “well-capitalized companies with near-term clinical de-risking events.”
As a result, deals and positive clinical momentum will need to continue if the sector is to thrive in the post-rate hike environment, the firm said.
“Companies with attractive assets, sufficient capital, and clear catalysts should continue to perform well, while earlier-stage or less differentiated companies may struggle to maintain recent gains,” BMO added.
Big Pharma is much more resilient to rate hikes, BMO noted. But the increase could still impact individual companies. The firm pointed to Pfizer as one example.
“A meaningful part of the investment case for Pfizer is the company’s dividend yield, which becomes less attractive on a relative basis as investors can generate higher returns from lower-risk fixed-income alternatives,” BMO explained.
Eli Lilly’s trillion-dollar valuation could also see pressure because it’s tied to long-dated growth, the analyst said.
Merck, on the flip side, has a strong pipeline and lower reliance on dividend support.
