Five stocks to cure your portfolio

Personalised medicine is a rapidly growing sub-sector of the pharma market as drug companies try to make the most of the money they pour into research and development. This is a market with enormous potential for growth. The big drug companies are likely to be the main beneficiaries, but there are a number of small companies that have exposure to personalised medicine and the companion diagnostics required to ensure that patients are only given treatments that will cure them.

In the past there has been a focus on general treatments but there is an increasing realisation that drug companies need to identify the people that their treatments will prove beneficial to. Genetic variations in people affect whether a drug will work or not. This will help niche drugs that only work in certain people to be viable and it could mean that more general drugs will be better targeted leading to a reduction in their sales.

It has been estimated that it can cost $3.7 billion (£2.2 billion) to $11.8 billion (£7.2 billion) to bring a new medicine to the market and some of these treatments work on fewer than 50% of patients. That is a lot of money to invest if there is no way of telling whether the drug will work on the patient receiving it. There could be drugs that do not succeed when they are trialled but might be effective if given to the right set of patients with the relevant genetics.

According to estimates published by accountant PwC, the US personalised medicine market was worth $232 billion (£141 billion) in 2011 and it was expected to be worth more than $452 billion (£274 billion) in 2015, with around $42 billion (£25 billion) of that figure accounted for by the diagnostics and therapeutic part of the market.

A companion diagnostic test is an in vitro diagnostic device or imaging tool that enables the safe and effective application of a treatment. The test identifies the presence or absence of a specific biomarker that is associated with a disease. Companion diagnostics are particularly advanced in identifying mutations in cancer tumour cells.

Regulatory incentive

The US Food and Drug Administration (FDA) is trying to encourage personalised medicines. Government and regulatory incentives and reimbursement policies are helping to develop the market. Focusing drugs on patients that will respond to them will stop money being wasted on drugs that have no effect.

The personalised medicine and companion diagnostics market is growing rapidly in Europe and North America, but it has hardly taken off in other parts of the world, including China. This leaves enormous scope for further growth.

Currently, the main focus of personalised medicine is on cancer treatments, but a McKinsey report on the sector published in 2013 says that immunology/transplant, central nervous system (CNS) diseases, paediatrics, pre-natal, infectious diseases and cardiovascular areas all have significant potential to benefit from personalised medicines.

Breast cancer drug Herceptin is the most well-known example of a treatment that is not effective on 100% of women but works on specific women. Herceptin is a treatment that targets the amplified human epidermal growth factor receptor 2 (HER2) gene, which occurs in between 20% and 30% of breast cancer patients. If Herceptin were given to every breast cancer patient then it would fail to have an effect in the vast majority of cases, and that is why a companion diagnostic was required to identify who should be given the treatment.

A number of different firms have developed tests approved by the FDA that can be used to identify the amplification of the HER2 gene and assess whether the patient would respond to treatment with the drug.

A large number of hyper-mutated genes have been identified in the four main types of cancer tumour, but only a limited number are thought to be the drivers of the cancer.

Companies to watch for

AIM-quoted Scancell, which is developing a skin cancer treatment called SCIB1, is collaborating with ImmunID, in order to assess which patients will react the best to the treatment. ImmunID has developed ImmunTraCkeR, which evaluates the patient's immune status using a liquid/blood biopsy. SCIB1 has already shown that it has potential to extend survival times in melanoma patients. The collaboration with ImmunID will enable analysis of the data in order to better target the treatment.

Drug development is risky and uncertain and the alternative way of gaining exposure to personalised medicine is via the companies that provide diagnostics services in this area.

The recent strategic review by EKF Diagnostics, and subsequent disposal talks, has highlighted the potential of its molecular diagnostics business, which has significant potential in the companion diagnostics area.

Bristol Myers Squibb's colon cancer drug Cetuximab is approved specifically for tumours where epidermal growth factor receptor (EGFR) is upregulated. EKF's PointMan technology can identify biomarkers for EGFR and other cancer biomarkers and should gain CE regulatory approval before the end of the year. The acquisition of Selah Genomics brought with it the PrecisionPath platform to guide the selection of chemotherapies to treat cancers.

EKF's plan was to sell the more mature point-of-care business so that it can concentrate on the fast-growing molecular diagnostics business. EKF has also received a bid approach for the group by Jinjing Group, which is undertaking due diligence. It is unclear how much the bid will be worth.

Big exposure

The AIM-quoted company that has the most significant exposure to the personalised medicine market is Horizon Discovery. The focus of the business is to provide tools and services that are required in personalised medicine.

Horizon is one of the largest providers of these services in what is still a relatively fragmented global market. In fact, Horizon claims to be the world's leading gene-editing company. The original business has been supplemented by the acquisitions of CombinatoRx, which brought with it the cHTS platform and Chalice analytics software used to identify potential cancer treatments, Sage Labs, which produces transgenic disease models for preclinical research, and Haplogen Genomics, which has technology to engineer human cells.

Horizon has been recognised by its peers as a significant participant in the sector and in 2013 it was named most promising company at the Personalised Medicine World Congress.

Horizon remains loss-making but it is growing organically, through collaborations and by acquisition. It generated revenues of £3.52 million in 2011 and this figure increased to £11.9 million in 2014. The latest interim revenues have more than doubled to £8.55 million.

Horizon is investing £10 million in its own drug research and development, so it also offers the larger, but much riskier upside, of personalised drug development. A research collaboration has been signed with AIM-quoted Redx Pharma, where the two companies will share costs in proportion to their research activities and a revenue share has also been agreed if a treatment is out-licensed. Horizon will provide analysis at a molecular level of a pan-RAF inhibitor programme focused on colorectal cancer.

Horizon raised £40 million gross at 180p a share when it joined AIM in March 2014. Earlier this year £25 million was raised at 190p a share. In recent months the share price has fallen below those placing prices. Being loss-making means that there is no floor to the share price provided by earnings. There is still £32.5 million of cash in the bank, though. The shares are a good, long-term investment but there is still some way to go before profitability will be reached.

The profitable option

Fully-listed Source BioScience also has a significant exposure to personalised medicine, but unlike Horizon it has a profitable base of healthcare and storage services operations. Source has particular expertise in diagnostics and DNA sequencing.

Source's pharmacogenics operations can provide information on how variations in DNA can affect the way an individual patient responds to a drug and whether the drug will be effective or ineffective. Genotyping of DNA can be used to assess indicators of patient response to treatment and help to develop personalised treatments.

In the first half of 2015, Source's revenues were flat at £12.8 million, but pre-tax profit was 39% higher at £1.2 million. That is because there was growth in the laboratory services operations which are higher margin. Much of this growth is coming from companion diagnostics services for cancer. The strategy is to move into other disease areas.

Source is forecast to make a 2015 pre-tax profit of £3.59 million, rising to £4.26 million in 2016. At 16.88p a share, Source is trading on around 20 times prospective 2015 earnings. The business is cash generative and the rating reflects its potential.