These Biotechs Have Up To 100% Upside In 2014

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Although almost any market action can be explained away -- in hindsight -- some trends will remain a deep mystery.

Major biotech stocks rallied sharply throughout 2013, as I noted in this column, but smaller biotechs inexplicably sold off sharply after Labor Day. My view: In the absence of any clear explanation of why smaller biotechs should suddenly fall deeply out of favor, lower stock prices should lead investors to give these stocks a fresh look.

Indeed, that scenario played out as expected. Since my mid-November profile of Regulus Therapeutics (Nasdaq: RGLSD), Threshold Phama (Nasdaq: THLD) and Synergy Pharma (Nasdaq: SGYP), these three stocks have rebounded, 24%, 12% and 31% respectively. That's an impressive six-week rally, and likely signals that this out-of-favor sector is rotating back into favor. I think these three stocks remain undervalued and will be tracking them in the year ahead.

With that in mind, here are three other biotechs that have massive potential upside, according to the Wall Street analysts who follow them.

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1. Esperion Therapeutics (Nasdaq: ESPR)​
This firm is developing a new drug, ETC-1002, that has shown great promise in treating people with high cholesterol for whom statins have not been helpful or have had problematic side effects. Esperion's chairman, Roger Newton, actually spearheaded the development of Lipitor, which went on to rack up more than $10 billion in annual sales for Pfizer (NYSE: PFE).

But even Newton's enviable track record and the massive market potential of the cholesterol market couldn't save this stock from sinking. It fell sharply after a successful IPO and only has only recently rebounded in tandem with other small biotechs.

Jason Butler, who follows Esperion for JMP Securities, sees the pullback as a great opening. In response to very favorable clinical trial data that were released in mid-November, Butler reassessed the net present value of future potential revenue streams for ETC-1002 and figures this stock is worth $34. That's more than 150% above the current share price.​

 

2. Verastem (Nasdaq: VSTM)​
When surgeons successfully remove cancerous tumors from a patient, they are hesitant to issue a clean bill of health. That's because dormant cancer cells may still be lurking out of sight, leading to a chance that the cancer will return.

This company is tackling that problem by going right after the stem cells that can cause tumors to regrow. Identifying cancer stem cells (CSCs) is tricky because they don't always show up in diagnostic tests. Verastem has found ways to unmask these hidden cells, and once they're identified as being present, suitable therapies can be targeted at them.

Verastem is developing several drugs that inhibit the development of CSCs. The lead drug, VS-6063, is in Phase II trials and is targeting mesothelioma, though management believes that the underlying chemistry of the drug will make it suitable in pursuing a wide range of cancers.

Analysts at Jefferies believe that Verastem's drug have shown solid results thus far in clinical testing, and expect the company's drugs to start reaching the market by 2016. Their $21 price target is 75% above current levels. Cantor Fitzgerald sees shares rising to $22. What does this firm look for in a solid biotech? "It all boils down to a mix of candidates, company personnel, milestones and other catalysts that drive value into the shares, and we find Verastem to have a compelling mix."

Company insiders agree. Directors Chris Westphal and Richard Aldrich have been buying shares throughout the second half of 2013 as part of an automated purchasing plan.​

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3. Insmed (Nasdaq: INSM)​
This drug developer also saw its shares pull back in the summer biotech rout, and though shares have rebounded, they still hold considerable upside, according to Wall Street analysts.

Lung disease is a potent killer, ranking as the third-leading cause of death behind heart disease and cancer, and taking more than 100,000 American lives every year. For many sufferers, existing treatments have proven ineffective, due to an inability to precisely target the damaged airways.

Insmed's Arikace could be a game-changer. It's an inhalable antibiotic that can be delivered right to the site of serious lung infections. Equally important, the drug doesn't circulate beyond the targeted site, which has led to very impressive safety results thus far in clinical testing.

Analysts at Lazard applaud management for designing clinical trials that help highlight the drug's efficacy and also meet the strict criteria for approval that has been established by the FDA. "The nuances of the trial design and endpoint selection versus current standard of care require a deeper understanding to appreciate why success is likely under a variety of potential outcomes," they note. Their $28 price target is 60% above current levels.

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Risks to Consider: Biotech stocks are quite volatile, and as this past summer's sector rout showed us they can fall out of favor without much notice.

Action to Take --> Considering how expensive the large biotech stocks have become, it pays to keep focusing on smaller, less loved biotechs, some of which trade far below their target prices. Those target prices reflect a wide range of outcomes, but they could be handily exceeded if these companies succeed in bringing their key drugs to market.

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