Investors looking for coverage this year would do well to seek safe haven in large-cap pharmaceutical stocks, a trend that is likely to continue into 2023. The NYSE Arca Pharmaceuticals Index is up 3.8% year to date as of at Tuesday’s close, compared with a 19.8% drop in the S&P 500 over the same period. However, the rising interest rate environment and the desire to avoid risky bets contributed to a difficult year for small- and mid-cap biotech stocks. But the outlook for the group could improve next year as new drug launches, product approvals and a return to M&A activity boost the stock’s value, some investors say. Although the Nasdaq Biotech Index is down 10.9% year to date, it has climbed 7.6% over the past three months as of Tuesday’s close. That gain outpaced the quarterly performance of the Russell 2000 (down 3.7%), the S&P 500 (down 2.1%) and the Nasdaq (up 1.5%). Large-cap pharmaceutical stocks benefited from widespread fears of an economic downturn. The thinking is that even in a recession, consumers will still need to seek health care services. That sentiment will continue to push the group through at least the first half of 2023. There are other catalysts for pharma stocks, such as expected drug and new product launches from this year’s M&A, as well as easing foreign currency pressure. Investors are very focused on advances in the treatment of Alzheimer’s disease, new weight loss drugs and the development of gene editing. The Inflation Reduction Act provided some clarity around drug pricing, which should help health care stocks. With a divided Congress, there is less risk of new legislation counteracting current rules. Passed in August, the IRA caps Medicare drug price increases at the rate of inflation and provides rebates to patients after they reach catastrophic coverage levels. But the focus will be on how companies position themselves strategically, as the law also mandates drug rebates after therapies have been on the market for 9 years for small-molecule drugs or 13 years for biologics. A top performer with a job opportunity On Tuesday, Barclays named Merck as one of its top picks in the sector. Shares are up 43% year to date, but Barclays’ $128 price target suggests another nearly 17% upside from Tuesday’s close. Analysts on average have a $113.86 price target on the stock, according to FactSet. “Looking ahead to 2023, we see a dynamic year where we expect the company to be able to achieve some gains in Keytruda [late-cycle managment] efforts, significant progress in the progress of [cardiovascular] franchise and continuous operational excellence with intact and moderated Keytruda/Gardasil drivers [foreign exchange] headwinds (after $2 billion in ’22),” Barclays analyst Carter Gould wrote in a research note. Gould also said 2023 will be a “make or break” year for Cytokinetics, which is expected to deliver additional data in the second half of 2023 for aficamten, a treatment for thickened heart muscle known as hypertrophic cardiomyopathy. The analyst said the stock’s $4 billion market cap could double if the data is positive. Cytokinetics shares declined up 2.5% year-to-date. The average target price, according to FactSet, is $62, or nearly 40% above the stock’s closing price on Tuesday. M&A-boosting M&A activity has long been a major catalyst in the sector. interest rates and an uncertain economic outlook have muted deal activity in general.However, big pharma has had no choice but to seek to e supplement their growth with acquisitions. Many are facing expiring patents and need to replace those sales to continue growing. The result was a modest increase in deal value this year. The largest was Amgen’s $27.8 billion bid for Horizon Therapeutics, maker of Tepezza, a drug to treat thyroid eye disease. It continued to buy Amgen and sharpened its focus on rare diseases. In August, Amgen agreed to buy ChemoCentryx, which makes treatments for rare autoimmune diseases. Pfizer, fresh off the success of its Covid vaccine and treatment, has closed two deals this year. There was the $11.6 billion buyout of Biohaven Pharmaceuticals and the $5.4 billion purchase of Global Blood Therapeutics. Biohaven allowed Pfizer to add anti-migraine drug Nurtec ODT to its portfolio, while Global Blood added an oral treatment for sickle cell disease. None of these were megamergers like those in 2019, but analysts took the Amgen deal announced just days ago as a sign that the pace could pick up in 2023, especially given that many biotech stocks are traded at extremely low values. IPOs slow to a crawl It won’t take long to see a surge in new biotech offerings. According to William Blair, there were 16 new issues through December 14, raising a total of $1.6 billion. That’s well below 2021, when a record 92 companies debuted, raising a whopping $17.3 billion. Secondary offerings have also been slow, but several companies that have provided strong clinical data have been able to raise funds, William Blair analysts said. They counted 96 deals this year that raised a total of $17.3 billion. By comparison, $24.8 billion was raised last year in 187 separate deals, according to William Blair. Among this year’s deals were Alnylam Pharmaceuticals, Karuna Therapeutics, Nkarta and Vaxcyte. Alnylam has an average overweight rating, while the other three stocks are averagely rated a buy, according to FactSet. Given that backdrop, William Blair analyst Matt Phipps said he expects later-stage biotechs to continue to outperform earlier-stage companies, which are inherently riskier bets. “A lot of that is due to the mergers and acquisitions we’ve seen recently,” Phipps said, explaining that acquisition targets have been companies that have had commercial success or positive data from phase 3 trials. Gene therapies in focus Investors will closely monitor the progress of several gene therapies, according to Phipps. He singled out UniQure, a pioneer in AAV gene therapy that is covered by William Blair analyst Sammy Corvin, and BioMarin, which is working on approval for Roctavian, a treatment for severe hemophilia A. UniQure won approval in November for Hemgenix, a first-in-class treatment for adult patients with hemophilia B. Gene therapies have high prices but can change patients’ lives. With a list price of $3.5 million, Hemgenix is currently the most expensive drug in the world. “Yes, these are expensive therapies,” Phipps said. “It’s quite laborious … getting the patient to go through all the paperwork with insurance, making sure all the care is set up to go through the whole process … Making sure those [therapies] can have good traction, it’s really going to read the entire gene therapy industry.” The argument for these treatments is that they are one-time therapies and will save money over time. In the case of Hemgenix, successfully treated patients will be able to skip prophylactic infusions and no more costly bleeding episodes, potentially saving millions over the patient’s lifetime. UniQure shares closed at $23.03 on Tuesday and are up 11% year to date. According to FactSet, the stock has an average rating of buy and a price target of $51.59, which means it could more than double in value over the next year. Phipps’ top pick in his coverage universe is the better-rated Chinook Therapeutics. The stock has a market cap of $1 billion and has risen 54% over the past year. According to FactSet, its average price target is $35, or more than 39% higher than its current price. Chinook, which focuses on rare kidney disease ia, is well-funded, with its current money likely to provide it with a runway until 2025, according to Phipps. He expects a steady stream of clinical updates to help boost the stock’s value. “They’re just really well positioned in this space with two drugs, one already in Phase 3, with Phase 3 results expected in Q3,” Phipps said. If approved, this drug, atrasentan, would be the second ETA inhibitor on the market for the treatment of chronic kidney disease IgA nephropathy, but Phipps expects the drug to still have a significant market opportunity. The second drug, BION-1301, is causing more excitement, according to Phipps, because it appears that it may actually modify the disease by reducing protein build-up in the kidneys.