Biotech stocks are back in favor thanks to two recent major developments that led to a rally in the sector. The first catalyst was Gilead Sciences’ (GILD – Free Report) announcement that it will be acquiring immunotherapy focused company, Kite Pharma (KITE – Free Report) while the FDA approval of the first gene therapy in the United States, Novartis AG’s Kymriah, boosted the sector further.

The Gilead-Kite deal has raised expectations that the sector will finally see more merger and acquisition (M&A) deals in the coming quarters. Moreover, companies involved in CAR-T treatment like Kite saw their shares shooting up on hopes that more M&A deals will be announced in this segment of the market. 

Meanwhile, the approval of Novartis’ CAR-T therapy, Kymriah, also gave the sector a boost indicating the beginning of a new era in the treatment of cancer. The path-breaking immunocellular therapy is a one-time treatment that uses a patient’s own T cells to fight cancer.

Year to date, the Nasdaq Biotechnology Index is up an impressive 26.1%, representing a sharp contrast to the Index’s performance during this same time period last year when it recorded a decline of 18.2%.

A key reason for last year’s dismal performance was the drug pricing controversy which weighed on the sector a major part of the year. However, investors now seem to be more comfortable with the drug pricing scenario and are willing to look at the fundamentals of the sector.

A key question that remains on the minds of investors is whether the rally will continue and what are the factors that will drive the same.

Firstly, this is an industry that will continue to witness demand for its products given an aging population and the increasing prevalence of a wide variety of diseases. Strong pipelines, innovative treatments, impressive results, and increased health care spending should support growth. Trump’s pro-business stand is also expected to benefit the sector.

A faster drug approval process and the proposed removal of outdated regulations that drive up costs and slow down innovation should also work in favor of the sector. The FDA has approved far more drugs so far in 2017 than it did in the whole of 2016. The sector will receive an additional boost if more M&A deals are announced though companies are likely to adopt a “wait and watch” stance as they await more clarity regarding the drug pricing situation and tax reforms. Another major deterrent could be high valuations with companies remaining wary of bidding wars leading to over-priced deals.

That said, licensing deals should continue especially in orphan and rare disease areas as well as highly sought after therapeutic areas like immune-oncology.

Picking the Right Stocks

Picking biotech stocks can be a bit tricky given the “high risk – high returns” nature of the industry. Moreover, the estimate revision trend for the sector is not very encouraging. The growing presence of biosimilars, a slowdown in growth of legacy products and high profile pipeline setbacks are also challenges for the sector.

Keeping these factors in mind, we have zeroed in on five biotech stocks that currently hold a strong Zacks Rank and look well-positioned.

Regeneron Pharmaceuticals, Inc. (REGN – Free Report) : Tarrytown, NY-based Regeneron’s key areas of focus include eye diseases, heart disease, allergic and inflammatory diseases, pain, cancer, infectious diseases and rare diseases. While eye drug, Eylea, the company’s key growth driver continues to perform well, Regeneron has been working on diversifying its portfolio and gained FDA approval for two drugs this year – Dupixent (moderate-to-severe atopic dermatitis) and Kevzara (moderately to severely active rheumatoid arthritis). Both drugs have blockbuster potential.

The company also has a strong pipeline and has an eventful second half of the year coming up with key mid-to-late stage pipeline catalysts lined up. Regeneron just reported positive top-line phase III data on Dupixent for asthma and is now looking to go ahead with a U.S. filing by year end. Dupixent should also gain EU approval for the eczema indication in the third quarter. Regeneron is evaluating Dupixent in the pediatric atopic dermatitis setting. Another important data readout scheduled for the second half of the year is on the company’s PD-1 antibody REGN2810, for cutaneous squamous cell carcinoma (“CSCC”), the second most common skin cancer after basal cell carcinoma and the second deadliest skin cancer after melanoma. Positive data would allow the company to file for FDA approval in the first quarter of 2018.

Meanwhile, Eylea is being evaluated in combination with nesvacumab. Top-line data from two phase II studies – one in wet age-related macular degeneration and another in diabetic macular edema – are expected in the fourth quarter of the year.

Regeneron, a Zacks Rank #1 (Strong Buy) stock, has gained 28.4% year to date, substantially outperforming the 15.6% rally of the industry it belongs to.