AI Could Give A Booster Shot To Biopharma Stocks

Excitement about the AI revolution has had investors scrambling to buy up shares of Nvidia, Microsoft, and other tech giants. But by focusing on those direct AI plays, they may be missing an important potential winner: biopharma. Morgan Stanley’s researchers anticipate that the field will thrive in an AI era. So let’s take a look at why and see how you might invest in its vim and vigor.

What makes AI so good for biopharma?

Think of biopharmacy, or biopharmaceuticals, like digging through nature's toolbox to create drugs. It uses living cells and organisms to make treatments like cancer-fighting antibodies, Covid-19 vaccines, insulin, and gene therapies for inherited diseases. It’s a subset of biotech, a field that combines biology and technology to develop different types of products (meaning: not just drugs). The big deal about biopharma is that it can treat conditions we couldn't even touch before. And because it uses biology, these treatments can hit diseases right on the mark, often with fewer side effects than a traditional pharmaceutical remedy.

Biotech firms, in general, are already huge fans of AI. And over 60% of biopharma companies are already using AI and machine learning to interpret data and run clinical trials, according to Morgan Stanley, while nearly half are using it for discovery and research. And that’s just at the very surface level. Dig deeper and the biopharma industry appears very well-positioned to unlock the AI benefits across multiple areas of the business model. Here are four of them:

Drug discovery. Finding new drugs is like finding a needle in a haystack for biopharma companies. It's not just because biology is complex and the number of possible drug molecules and proteins is mind-bogglingly huge. It's also because developing a drug is a marathon, not a sprint, and an expensive one at that. It often takes more than a decade from discovery to approval for a new drug, and the costs usually exceed $1 billion. AI can help generate more potential drug candidates, boost the chances of success for each candidate, and streamline the process to shrink the research and development tab. Put more simply, it can help find that needle much faster, and much cheaper.

Clinical drug development. Clinical trials gather data on how effective and safe a drug is when used on actual humans, and that helps determine whether it gets approved. Those trials are no small endeavor: they involve thousands of participants across hundreds of global sites, all following detailed protocols. This generates a vast amount of patient data, but it can lead to logistical and quality control challenges. AI could be a game-changer here: it has the potential to streamline the process and make everything more efficient. Plus, it could provide new insights into clinical development strategies and actually speed the design of clinical trial studies.

Manufacturing. With lingering supply chain hiccups, climbing inflation, and growing geopolitical tensions, pharma manufacturing has its share of risks. AI may help there: it could help spot potential bottlenecks and risks across the whole production chain, making the whole process run more smoothly. And on the quality control end of things, AI could reduce batch errors and cut the time it takes to inspect the product.

Physician-patient engagement. Like seemingly everything, healthcare's going digital, and pharma companies are having to up their communication game. They're not just chatting with consumers, but also with their sales teams and doctors. And AI could be the ultimate conversation starter. With digital advisors, smarter data analysis, and tech to boost engagement, AI could help make chats between patients and doctors more frequent and fruitful. Looking ahead, AI might even whip up new products, like diagnostic wearables (like a smarter Fitbit or Apple Watch), personalized drugs, or genetic medicines.

What’s the opportunity then?

Healthcare sectors’ valuations are a lot more fit (and less bloated) than other sectors, and looking at recent price action for the sector it seems that investors aren't exactly buzzing about its outlook (and that’s especially true in biopharma). But there could be room for a pleasant surprise and a more-vigorous-than-expected-upside here.

On one hand, AI could be a major money-saver, slashing the cost of developing and manufacturing drugs by between 20% and 40% in most cases. On the other hand, a higher success rate for new drugs could seriously boost long-term revenues: each new drug that gets the green light could mean steady cash flow for years to come. And that alone could be a game-changer: Morgan Stanley estimates that every 2.5% bump in pre-clinical development success rates could lead to 30 or more additional new drug approvals over a decade. (Now, to put that in context: the FDA approves only about 43 per year). With each one generating high-profit margins and huge sales, Morgan Stanley estimates this could add an extra $70 billion in value to the biopharma industry.

But also: the combo of more successes and lower costs could make biopharma stocks less of a gamble for investors. And that might help close the valuation gap between healthcare and safer, more solid sectors like consumer staples. A higher valuation multiple could significantly boost healthcare stocks’ returns.

The valuation of biopharmaceuticals (red line) versus consumer staples (blue line). Biopharma’s valuation discount could shrink as AI revolutionizes the field. Source: Morgan Stanley.

Investing in biopharmaceuticals isn't just about the potential for big gains. It's also about playing defense and adding some variety to your portfolio. Thanks to things like intellectual property rights and high barriers to entry, plus the kind of demand that keeps growing no matter what the economy's doing, biopharma companies enjoy some of the fattest margins in healthcare and are also protected by a strong competitive edge. That could make them a smart place to be if the economy hits a rough patch. And, since they're more influenced by the success or failure of their new drugs, and less tied to traditional macro factors like interest rates and inflation, they can add a different (diversifying) flavor to your portfolio mix.

The easiest way to invest in biopharmaceutical companies is to buy a diversified ETF like the iShares Biotechnology ETF (ticker: IBB; expense ratio: 0.44%), or the SPDR S&P Biotech ETF (XBI, 0.35%). But if you want a more speculative, and genomic-focused ETF, you might want to check out the ARK Genomic Revolution ETF (ARKG; 0.75%).

Then again, you can also venture into individual stocks. Morgan Stanley highlighted Pfizer (PFE), Johnson & Johnson (JNJ), Merck (MRK), and Moderna (MRNA) as having the most potential to gain within big-cap biotech stocks, and Evotec (EVTG), Exscientia (EXAI), Recursion (RXRX), and Schrodinger (SDGR) within smaller caps.