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The recent market decline this year caused Tekla Life Sciences Investors (NYSE:HQL) to drop 10.5% below its net asset value [NAV]. This CEF typically doesn’t get much price appreciation over time. However, the sharp dips which occasionally occur like in 2020 and over the past year present buying opportunities for this CEF.
Tekla Life Sciences can be attractive for income investors since its distributions yield over 10% annually. This CEF comes from Tekla’s collection of funds which also includes: Tekla Healthcare Investors (HQH), Tekla Healthcare Opportunities (THQ), and Tekla World Healthcare Fund (THW). I chose to focus on Tekla Life Sciences right now because this fund is currently trading with the greatest discount to NAV as compared to the other Tekla funds.
Tekla Funds Comparison
| HQL | THW | HQH | THQ | |
| Yield | 10.6% | 10.97% | 10.3% | 7.3% |
| Discount to NAV | 10.5% | 0% | 8.7% | 8.9% |
source: Seeking Alpha & Teklacap.com
Top 5 Holdings
The Tekla Lifesciences Fund focuses on investing in biotechnology, pharmaceutical, diagnostics, and other healthcare-related companies. The top five holdings in the fund as of September 30, 2022 are: Gilead Sciences (GILD) which comprises 8% of the fund, Amgen (AMGN) at 7.5%, Vertex Pharmaceuticals (VRTX) at 7%, Regeneron Pharmaceuticals (REGN) at 4.7%, and Illumina (ILMN) at 4%.
The current largest holding, Gilead, has treatments for HIV/AIDS, liver diseases, hematology, oncology, and more. Gilead currently has a hold rating according to SA’s quant system. The company is undervalued with a low forward PE of 10. However, Gilead has low expected annual 3 – 5 year EPS growth of 1.25%. The company may need a lucrative acquisition or more blockbuster drugs to drive higher growth.
Amgen is a buy according to Seeking Alpha’s quant ratings system. The stock pays a 3% dividend and is fairly valued with a forward PE of 14. Amgen has strong profitability metrics with a gross margin of 76%, net income margin of 25%, an ROE of 123%, an ROIC of 15.6%, and an ROA of 11%. The company is expected to grow earnings at about 4% annually over the next 3 – 5 years. The company’s reasonable valuation and steady growth can help drive the stock higher over time and secure future dividend increases.
Vertex Pharmaceuticals focuses on developing and marketing treatments for cystic fibrosis. The stock trades with a forward PE of 21, but a low PEG ratio of just 0.82. Vertex is a high growth company with 3 to 5 year expected annual earnings growth of 26%. This high growth has the potential to drive the stock to outperform the S&P 500 which would help HQL’s performance. Vertex has a buy rating according to SA’s quant ratings system.
Regeneron Pharmaceuticals develops treatments for various conditions including diseases related to the eyes, dermatitis, asthma, metastatic or locally advanced cutaneous squamous cell carcinoma, and more. Regeneron has a fair valuation with a forward PE of 17. The company is expected to experience an annual earnings decline of about 5% over the next 3 – 5 years. Regeneron has 11 drugs in its pipeline in the Phase 3 development stage. Success with some of these could help drive higher growth in the future. SA’s quant system has a hold rating for the stock.
Illumina provides sequencing and array-based solutions for genetic and genomic analysis. The company’s solutions are used in various markets such as life sciences, oncology, agriculture, reproductive health, agriculture, and more. Illumina tends to maintain an overvaluation with a forward PE of 79. The company could also use a growth boost as earnings are expected to decline by 5% to 6% per year over the next 3 – 5 years. SA’s quant system has a hold rating for the stock.
Keep in mind that the earnings estimates could change if lucrative acquisitions are made by these companies. Also, estimates could change when newly FDA-approved drugs come onto the market. Gilead has a new positive catalyst with the August 2022 approval of Sunlenca (lenacapavir), the only twice-yearly treatment for HIV, which is estimated to generate over $1 billion in annual revenue by 2027, making it a potential blockbuster.
Recent Catalysts for the Top 5 Holdings
Amgen had RIABNI FDA approved in June 2022 for adults with moderate to severe rheumatoid arthritis. This newly approved indication adds to RIABNI’s previously approved indications for Non-Hodgkin’s Lymphoma, Microscopic Polyangiitis, Chronic Lymphocytic Leukemia, and Granulomatosis with Polyangiitis. About 1.3 million people suffer from rheumatoid arthritis in the United States.
Vertex had a recent FDA approval for the expanded use of Orkambi for cystic fibrosis in children aged 12 months to 24 months. Vertex also announced that it desires to acquire ViaCyte for $320 million, a company that has a treatment for Type I diabetes. The successful acquisition of ViaCyte would eliminate the company as competition as Vertex also competes in this market.
Regeneron, in conjunction with Sanofi (SNY), recently received FDA approval for Dupixent for treating adults with prurigo nodularis on Sep.28, 2022. This is the first and only FDA approved treatment for prurigo nodularis, replacing the standard treatment for the condition with topical steroids which can have severe side effects when using it for long periods of time. There are about 75,000 people with prurigo nodularis that need new treatment options. The cost of Dupixent for uninsured patients is $56,000 per year. That leaves a total potential market size for this indication of $4.2 million.
Regeneron also has a pending FDA decision date on February 11, 2023 for EYLEA Injection to treat Retinopathy of Prematurity in preterm infants. EYLEA has been a blockbuster drug for Regeneron as it has been approved to treat multiple conditions. Annual sales of EYLEA are expected to be $3.4 billion by 2027. Keep in mind that Regeneron will face competition from Roche’s (OTCQX:RHHBY) Vabysmo, which was FDA approved in January and requires fewer doses. Expected annual sales of EYLEA were reduced from $4.6 billion down to $3.4 billion by about 2027 to account for this competition.
Tekla Life Sciences Investors Long-Term Outlook
The companies comprising the fund may not all be high growth stocks. However, these companies have important treatments for various conditions. The companies in the fund also have pipelines which can drive growth in addition to any acquisitions that they may complete in the future. This provides the companies with steady revenue and earnings growth that are not as economically sensitive as consumer discretionary or cyclical stocks. As a result, HQL can provide steady dividends with a high yield due to the stability of the companies comprising the fund.
Keep in mind that the fund’s underlying price could still experience declines during market corrections, bear markets, and recessions. However, a fund like this is not likely to experience declines as drastic as overvalued economically sensitive companies. Overall, the fund can provide an attractive yield for income investors as they wait for a higher underlying price as we move further into the decade. Since the fund is trading below NAV, investors are getting HQL at an attractive valuation.
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