CYTK - LABU: Leveraged Biotech ETF Review

Summary

• Biotech stocks have pulled back and offer better risk to reward for investors, Direxion Daily S&P Biotech Bull 3x Shares ETF is a popular way to trade them.
• M&A is likely to drive prices for mid-cap and small-cap biopharma.
• Using a leveraged ETF like LABU is risky, even if it is in a favorable sector.

In this article, we will review investing in a biotech leveraged exchange-traded fund, or ETF. The Direxion Daily S&P Biotech Bull 3x Shares ETF ( LABU ) seeks to make 3 times the daily return of the S&P Biotechnology Select Industry Index. This index includes domestic companies from the biotechnology industry. LABU is a modified equal-weighted index designed to measure the performance of the biotech industry.

Biotech companies can be valued on potential pipelines and not just on revenues and profits like most companies. Since drug development requires a lot of capital, it is raised through venture capitalists, strategic investors, and public markets. The value of the drug grows as it moves through the stages of drug development. The value of the drug is dependent on the probability of success at each stage of the drug development program, in market size, and cost to commercialize. Biotech companies can be incredibly valuable if their drug has been approved by the Food and Drug Administration ((FDA)) and is on its way to generating revenue.

Risks

Biotech companies are inherently risky as they likely won’t have any earnings or revenue and could be valued based on potential earnings. Biotech companies are also riskier as their success is dependent on approval from the regulators.

Using a leveraged fund to invest in a speculative sector adds exponentially to the risks. Leveraged funds have erosion due to beta slippage. Leveraged funds borrow money to amplify returns. In addition losses get amplified and due to daily rebalancing the overall returns will impact returns to the downside. For example on day one, if an exchange-traded fund ("ETF") is down 10%, then a 3X leveraged fund would be down 30% and it resets. The next day if the ETF is up 11% then it would be back to even. However the leveraged ETF would be up 33%, but it needs to be up nearly 45% to be back to even. Over time the down days reduce the overall return of leveraged funds.

Mergers and Acquisition

Biopharma deals drive prices of the overall biotechnology industry index. M&A is needed for biotech due to the expertise required to develop the drugs and then commercialize them. M&A was active in 2022 and could continue this year. The premium paid has been on the higher side as large pharmaceutical turn to newer drugs from mid-cap and small-cap biopharma companies.

Drug Approval

New innovative drugs that advance healthcare are reviewed by the FDA's Center for Drug Evaluation and Research ((CDER)). Some of the drugs can be molecular entities that the FDA reviews. Some of those reviewed by CDER have never been used in clinical practice. Others are related to previous approvals and will compete in the market.

About the Fund

The Direxion Daily S&P Biotech Bull 3x Shares ETF ( LABU ) seeks to make 3 times the daily return of the S&P Biotechnology Select Industry Index. This index includes domestic companies from the biotechnology industry. LABU is a modified equal-weighted index designed to measure the performance of the biotech industry.

Fund Holdings

The top holdings of LABU are in the table below.

Chart of S&P Biotech ETF ( XBI ), which is the closest non-leveraged ETF similar to LABU.

Comparison of XBI and S&P 500 (SP500) chart. It shows that, despite huge outperformance at certain times, XBI retraces back towards the S&P 500.

Comparison of XBI and LABU illustrates reason not to hold leveraged ETF for the long term.

Review valuation and chart of the top holdings

Projected revenue for Madrigal Pharmaceuticals ( MDGL ) has been steadily increasing and is projected to grow more than 400% in 2024 and be more than 200% in 2025.

Earning which are currently negatively projected to become positive in 2025.

Chart of Madrigal shows a recent jump in price back to near highs as has been seen a few times in the past since the IPO.

Arrowhead Pharmaceutical's ( ARWR ) projected revenue is scheduled to grow triple digits in a couple of years.

Earnings are not projected to be positive until 2026.

Chart of Arrowhead ( ARWR ) has pulled back since early 2022 after a steep run up for a few years.

Projected revenue for Cytokinetics ( CYTK ) starts to ramp up from 2024.

Projected earnings should be positive in late 2024 but possibly in 2025.

Chart of CYTK is near all time highs, reflecting positive expectations.

Projected revenue for Akero Therapeutics ( AKRO ) is expected to grow slowly over the next couple of years. In 2027 it should grow to 75%.

Future earnings are projected to become positive in 2024 and then ramp up.

Chart of AKRO is near all time highs and is looking good from a technical perspective.

Projected revenue for Altimmune ( ALT ) is expected to grow starting in 2025 and grow triple digits for a number of years after that.

Projected earning become positive in 2028 and grow steadily after that.

Chart of ALT is near the lower end of the price range, and it dropped substantially in 2016-2017.

The valuation of biotech are based on projections based on pipelines of drugs and their potential in the coming years. The volatility of their charts are driven by news. The best way to own biotech for most investors is through an ETF for those reasons.

FINRA on Leveraged ETFs

Leveraged ETFs should be avoided unless a sophisticated trader uses them for day trading or a short time-frame with strict risk management. FINRA warning:

"Exchange-traded funds ('ETFs') that offer leverage or that are designed to perform inversely to the index or benchmark they track-or both-are growing in number and popularity. While such products may be useful in some sophisticated trading strategies, they are highly complex financial instruments that are typically designed to achieve their stated objectives on a daily basis. Due to the effects of compounding, their performance over longer periods of time can differ significantly from their stated daily objective. Therefore, inverse and leveraged ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatile markets."

Summary

For an equity investor, the biotech space is hard to invest in as there are a number of companies with no earnings. Pipelines can drive prices of biotech stocks, especially if it carries a premium for some other pharma company. The projected revenue and earnings for some of the biotech companies is way out into the future. That is a huge risk for investors. Biotech could be best considered as an investment through XBI or another non-leveraged ETF. My personal recommendation would be avoid Direxion Daily S&P Biotech Bull 3x Shares ETF.

For further details see: