Life Science Stocks: A Growing Market in 2010

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The company is also positioning its Acquity business, which makes high-performance liquid chromatology instruments that separate compounds into key constituents, for higher profit margins by moving the unit to Singapore next year. Ro predicts Acquity's margins can eventually expand by 2% to 3%, but he expects improvement of only about 0.5% in the first year after factoring in the negative currency translation. Ro's 2010 earnings forecast is $3.88 a share, compared with the consensus estimate of $3.74. Share buybacks with the substantial free cash flow the company generates will further increase earnings per share, he adds.

While the extra $10 billion that will be funneled from the stimulus funding into research grants is significant, the market's anticipation that the funding will end in 2011 could work against life science stocks, some pros believe. That's why Jeffrey McCormack, a portfolio manager of the Manning & Napier Life Sciences Fund (EXLSX), would prefer to find factors that will allow life science companies to achieve sustainable growth beyond 2011.

As the global economy improves next year, these companies will be able to continue to expand their customer bases on both an end-market and geographic basis, McCormack believes. Their revenues should grow two to three times faster than the rate of global growth in gross domestic product, he predicts.

Uses in nonmedical Industries

Although the future medical research prospects are lucrative by themselves, some analysts see a much bigger opportunity in applications across such other industries as environmental monitoring, water treatment, food safety, and forensics—all driven by stricter global regulation.

"These technologies' ability to differentiate and quantify compounds in a quick, cheap, and efficient manner makes them applicable to lots of other industries," says McCormack. "Early applications were in life sciences where the compounds in question were drugs. As we move forward, the compounds are air, water, and food, and you're trying to find the elements that don't belong or that we need to remove."

Two companies that McCormack thinks will benefit from the longer-term economic recovery and broader application of life science technologies are PerkinElmer (PKI) and Pall (PLL). PerkinElmer has a large environmental health business that generates more than half its total revenue and the company can take advantage of growing demand for stricter procedures to guarantee the safety of food produced in the U.S. and imported from overseas.

Pall is a major producer of filtration devices used in the biotech drug industry and in water treatment systems. About 70% of its revenue comes from outside the U.S., where water infrastructure is being developed more quickly than in the U.S. McCormack thinks Pall will be able to increase its annual revenues from emerging markets by at least 10% over the next five years.

If you're less confident about the prospect of a strong economic recovery, you may feel more comfortable with Millipore (MIL), says Ro at Leerink Swann. Half of its business is in less-cyclical filtration products used to produce biotech drugs. The company is expected to deliver good earnings growth for the next five years, no matter how the overall economy fares, he says. The other half of Millipore's revenue comes from reagents and sequencing kits.

"If you believe biotech drugs over the next five years will see a more prevalent position, [Millipore has] the best basis for that theme," says Ro. And because switching costs are high, biotech clients aren't likely to replace Millipore's filtration devices with cheaper alternatives. The fact that its products are applied universally across drug manufacturing processes means Millipore's growth is less reliant on a single drug, which makes the company an attractive acquisition target, he says.

Bogoslaw is a reporter for BusinessWeek's Investing channel.

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