Why Sarepta Therapeutics and Ariad Pharmaceuticals Fell

Yesterday saw a fair amount of volatility in the health-care sector after Goldman Sachs' literally downgraded  the entire sector, calling valuations for the majority of companies "fair." Being the first Monday of 2014, however, there were numerous analyst prognostications hitting the Street. Some of the particularly harsh ones sent their targets into a tailspin. Yet, I think it's important to remind investors that analysts' projections can be, and are, often wrong.

So here is my take on the notes by Citigroup analysts Yaron Werber and Jonathan Eckard that sent Sarepta Therapeutics and Ariad Pharmaceuticals spiraling downward yesterday.

Questions hang over Sarepta's Duchenne muscular dystrophy drug
In its note about Sarepta, Citigroup stated that they do not believe the mid-stage trial data for the company's flagship drug for Duchenne muscular dystrophy, or DMD, called eteplirsen will be accepted by the U.S. Food and Drug Administration, or FDA, for accelerated approval. Citigroup thus placed an eye-popping price target of $13 on the stock, more than 30% below where the stock started the day. Sarepta finished the day down over 8% on unusually heavy volume, and shares are down another 4% today as of the writing of this article.

Of particular interest, Citigroup suggested that the drug's approval will be delayed at least until 2017, if not longer. And that's what I think caused the panic. Because Sarepta doesn't have a commercially available drug and relies primarily on dilution to fund its operations, the thought of waiting multiple years for revenues sent investors packing.

It's also important to understand that eteplirsen is only the first in a series of exon-skipping drugs that dominate Sarepta's clinical pipeline. So the company needs to get eteplirsen approved before it can unlock the value in its early stage candidates.

So, what's my take? As I look at Sarepta's stately market cap of $705 million, I have to wonder how much of that is based on expectations that eteplirsen was close to an approval. Citigroup is essentially suggesting that Sarepta's market cap should be more in line with other developmental stage biopharmas that are years away from an approval. At the end of the day, I have to agree with this assessment. There are still major regulatory and clinical trial risks ahead for eteplirsen, and these do not appear to be factored into the current share price. So you might want to take a pass on Sarepta until the road ahead is clearer.

Ariad gets hammered
Ariad was also the subject of Citigroup's wrath yesterday. Bringing out the hammer, Citigroup's analyst Yaron Werber said there were "potential negative surprises" for the company's lead cancer drug Iclusig in the next 12 months, including lower than expected sales due to safety concerns. As a result, they called Ariad Shares "high risk." Even so, they did actually raise their former price target by 65%, although this was still close to 20% below where shares were trading at the start of the day. Considering the magnitude of the downgrade, Ariad shares performed reasonably well, only falling 4.62% in the session.

In case you haven't been following this story, Iclusig was placed on a partial clinical hold by the FDA last October due to excessive risk of blood clotting. However, the hold has now been lifted and the drug will be relaunched with a revised label.

How do I view Ariad going forward? I personally think the shares are fairly valued when viewed in light of the sky-high valuations pervasive throughout the sector. That said, Ariad is still far away from becoming cash flow positive due to rising clinical costs, so it needs Iclusig to take some of the pressure off the bottom line. The problem is that Iclusig was never meant to be a front-line treatment, and now it's revised label puts it squarely behind Novartis' two leukemia drugs imatinib and nilotinib. So you may want to wait on the sidelines with this one.

Foolish final thoughts
I personally take most analysts' projections with a grain of salt. After watching the biopharma sector for as long as I have, you get the feeling that the sector is simply too unpredictable to put much stock into yearly outlooks. Even so, Ariad and Sarepta appear to be particularly risky stocks this year because of the regulatory issues handing over their primary value drivers. So Citigroup does have a point in these particular cases. Consequently, you might want to look into the plethora of biotechs with better outlooks this year.