KeyBanc sees opportunity in tech-enabled drug discovery stocks (NASDAQ:ABCL)

KeyBanc has initiated coverage of the digital biology and tech-enabled drug discovery subsector, citing the biopharma industry’s growing appetite for products that can help speed drugs to market and reduce the exorbitant costs associated with drug development.

The investment bank kicked off its coverage by rating Abcellera (NASDAQ:ABCL), Absci (NASDAQ:ABSI) and Schrodinger (NASDAQ:SDGR) as overweight, and Certara (NASDAQ:CERT) as sector weight. The bank also included Codexis (CDXS), Recursion (RXRX) and Simulations Plus (SLP) in the subsector.

The companies have faced significant headwinds from a number of macro factors in recent months, including slowdowns in biotech funding and rising interest rates. But KeyBanc sees smoother sailing ahead for the subsector as drugmakers search for ways to reduce drug development costs.

In its recent note, KeyBanc pointed out that only 12% of drug candidates ever make it to market, with the process taking roughly ten years and costing around $2B.

“That’s where we see a large opportunity, as these technologies can leverage large amounts of data, significantly broadening the funnel of potential candidates that can be evaluated and can also screen more rapidly and earlier in the process when failure is less expensive,” the analysts wrote.

KeyBanc said it also believes drugmakers will utilize not just one but multiple technologies for drug development.

“We believe that these varying solutions in the marketplace are not competing for customer dollars, but rather providing novel alternatives to steps in the process, each with their own unique technology,” the analysts said. “This is not a zero-sum game given the complexity and cost to discover and test a new drug.”

Meanwhile, stock prices in the subsector have been under pressure for several months, creating what KeyBanc sees as an attractive entry point for long-term investors. In its note dated Dec. 4, KeyBanc pointed out that its tech-enabled drug discovery index was down about 6% year-to-date, compared with the S&P 500, which was up around 19%.

KeyBanc blamed higher interest rates and a slowdown in the biopharma end market for lower valuations and recommended investors take a longer-term investment approach.

“While we agree this presents some attractive buying opportunities in the space, we also think investors should take a more nuanced, company-specific approach over the next 12 months,” the analysts wrote.

The bank is particularly keen on companies that have stable software revenue from large life sciences and pharmaceutical clients, “healthy” balance sheets and sufficient cash reserves to support R&D investment.

KeyBanc views AbCellera as having a proven track record in drug development. The company has also been able to grow its partnerships by at least 20% annually over the last three years to 42. KeyBanc also noted that AbCellera has also been striking agreements where it can add value beyond the drug discovery process. The bank has a price target of $6 on the stock.

Absci, meanwhile, was highlighted for its “sharp focus” on generative AI to enable de novo design technology. KeyBanc also noted that the company now has four internal drug assets that have the ability “to create significant value inflection for the company with partnership potential.” KeyBanc set its price target for Absci at $3.

As for Schrodinger, KeyBanc said it liked the company’s recurring revenue growth in its software and services business, with a roughly 80% gross margin profile. The bank pointed out that Schrodinger also develops molecules in-house and through partnerships for both drug development and materials applications, “adding growth optionality and validating its platform.” Key Banc’s price target for the stock is $38.