Hedge fund guru Joel Greenblatt of the $7.13 billion Gotham Asset Management fund has revealed a bullish sentiment on three key pharmaceuticals. Greenblatt initiated new positions in Kite Pharma Inc (NASDAQ:KITE), Immunomedics Inc (NASDAQ:IMMU) and Valeant Pharmaceuticals Intl Inc (NYSE:VRX).
Greenblatt, ranked #54 out of 203 fund managers tracked by TipRanks, is not shy to reveal the secrets of his success. He sets out his “Magic Formula” in his work “The Little Book That Beats the Market”. The formula is designed to pinpoint the market’s top 30 stocks – cheap stocks with a high earnings yield and a high return on capital. Greenblatt claims the strategy has a 17-year annual return of 30% plus and beats the S&P 500 96% of the time.
But does Greenblatt’s formula really work? Researchers Douglas W Blackburn and Nusret Cakici of Fordham University recently found that the magic formula is “not so magical”. They plotted portfolios of long and short stocks for 23 markets in 4 global regions from 1991 to 2016, and found that the only region with significant return differential was Europe.
However, “much more magical” returns occurred when the researchers used EBIT instead of gross profit. This new formula is based on gross profit-to-tangible capital employed and gross profit-to-enterprise value. The result: a return differential of 0.88% (North America), 0.65% (Europe), 0.66% (Japan) and 0.62% (Asia). The study concludes that by “tilting the value -weighted portfolio toward inexpensive, profitable stocks away from expensive, unprofitable stocks one can actually beat global markets.” And crucially this new formula also significantly reduces risk so there may be some hidden magic after all!
Greenblatt has certainly generated impressive returns with the Gotham portfolio. The portfolio has gained 70.9% since June 2013 and has an annualized three-year return of 13.11%. The Sharpe ratio is also 2.19 compared to the ratio for the average fund of 1.22. However, while the fund’s measure performance (71%) easily beats the average hedge fund portfolio (53%) it nevertheless seriously undercuts the S&P 500’s impressive 91%:
So how did Greenblatt’s investing strategy play out in the last quarter? Let’s take a closer look at three of his most interesting pharmaceutical trades:
Kite Pharma Inc
In Q2, Greenblatt initiated a position in Kite Pharma with the purchase of 5,320 shares worth $552,000.
Was Greenblatt involved in the $12 billion takeover of Kite by Gilead Sciences (NASDAQ:GILD)? The deal, announced on August 28, will see Gilead paying $180/ share for the Israeli biotech which is developing novel CAR-T cell treatments against cancer. Shares in KITE leapt on the news by 29% to $179. Gilead shares are also up by 1.7% as the market digests the implications of the all-cash deal.
The move will help Gilead pivot into cell therapy and, more specifically, boost its oncology business. There are all much-needed catalysts for the stock as its key hepatitis C franchise continues to decline. The Car-T therapy aims to use the immune system to fight cancer using the body’s chimeric antigen receptor T cells. These cells are extracted and modified to fight cancer more effectively and then injected into the body.
The question is whether Gilead has overpaid for Kite Pharma, given that it has yet to receive approval for its leading cell therapy known as axi-cel. Maxim Group is confident that “Kite’s acquisition price is reasonable. While it will take time for the sales to build, and manufacturing hurdles exist we think the revenues will materialize. The deal is not likely to be accretive near term but it does position Gilead as a global oncology company and secures the company’s future.” He predicted that Gilead can generate $5 billion revenue from the deal.
Kite is expected to receive an answer from the FDA regarding its CAR-T treatment for a type of blood cancer called aggressive B-cell non-Hodgkin lymphoma as early as November. Kite is also working on treatments for multiple myelomas and solid tumors.
Overall the stock has a cautiously optimistic Moderate Buy analyst consensus rating. This breaks down into 3 buy and 6 hold ratings in the last three months. Following the takeover news two analysts downgraded the stock to Hold. Due to the sharp price spike, the $125 average analyst price target is now at a -30% downside from the current share price.
Greenblatt is now also an investor in IMMU with the purchase of 270,496 shares. The holding, valued at $2.388 million, has benefited from the stock’s recent 14% leap.
Shares in IMMU, a preclinical biopharma, rose from $10.50 to $11.84 on August 28. The likely reason for the leap is the just-announced $12 billion Kite Pharma/ Gilead deal. The deal had a knock-on effect on the share prices of CAR-T biotechs. Although Immunomedics is not directly involved in CAR-T biotherapeutics, it did reveal encouraging preclinical data from trials earlier this year on how select checkpoint inhibitor antibodies (bsAbs) can increase the potency of T cells. It is ultimately possible that this treatment could work alongside CAR-T cell immunotherapy to stop tumor mutations reducing T-cell efficiency.
Top Cowen & Co analyst Phil Nadeau reiterated his buy rating on IMMU on August 16. His price target of $15 represents big upside potential for the stock of close to 27%. And Nadeau is one of the best analysts to track on the stock- he has a 100% success rate and 46% average return on IMMU. According to Nadeau “we continue to think that IMMU is significantly undervalued” for the potential of its IMMU-132 antibody-drug conjugate (ADC) for the treatment of metastatic triple negative breast cancer (mTNBC). Final results from the Phase 2 trial for this drug will be presented in December with a potential FDA filing submission in March.
TipRanks reveals that the analyst consensus rating for IMMU is Moderate Buy with an average analyst price target of $13 (9.8% upside from the current share price).
Valeant Pharmaceuticals Intl Inc
Last but not least- Greenblatt took a new position in controversial healthcare stock Valeant Pharma. He now owns 823,406 shares valued at 14.239 million.
But now may not be the best time to be a Valeant investor. As if a $30 billion debt burden isn’t enough to deal with, the company has now been struck with a very unwelcome turn of events. According to reports, mutual fund company Lord Abbett & Co. has filed a securities fraud lawsuit against Valeant in New Jersey. The lawsuit claims that the fund purchased VRX’s debt securities at artificially high prices on the back of misleading information provided by Valeant.
The most disturbing part for VRX is that Lord Abbett is seeking huge damages of $80 billion under the RICO (racketeer influenced and corrupt organizations) laws of New Jersey. As VRX has only set aside $162 million for potential lawsuits, this new claim could spell big trouble for the pharma company. And in the worst-case scenario, the lawsuit could even encourage other companies to make similar claims, potentially damaging VRX’s crucial credit rating.
Perhaps unsurprisingly, Valeant has a Hold analyst consensus rating. In the last three months, the stock has received 3 buy, 7 hold and 3 sell ratings from analysts. Their average price target of $17.92 stands at a considerable 26% upside from the current share price.