These biotech stocks will benefit as generative AI speeds up drug discovery, Jefferies says

Jefferies suggests investors are underestimating the positive impact of generative AI on biotech, predicting it could significantly reduce drug development time and costs, potentially saving billions and increasing success rates. Despite near-term regulatory headwinds already priced in, Jefferies is optimistic about the sector's prospects, highlighting Amgen and Schrodinger as companies poised to benefit from AI integration, while noting Illumina and Danaher as other potential beneficiaries despite their current YTD declines.

Analysis

Jefferies asserts that investors are significantly underestimating the transformative potential of generative artificial intelligence within the biotechnology sector, which has faced a challenging period marked by a correction post-pandemic, higher interest rates, tariffs, and U.S. Department of Health and Human Services staffing reductions. This challenging environment is reflected in the SPDR S&P Biotech ETF (XBI) being down over 11% year-to-date, contrasting with a slight gain in the S&P 500. However, Jefferies projects a substantial boost from AI adoption in drug discovery, with senior analyst Michael Yee highlighting that AI could reduce drug development timelines by years—potentially from ten years down to seven or eight—and cut failure probabilities significantly, thereby saving billions of dollars and enhancing return on investment. Yee anticipates 'tremendous progress' within five years from drugs developed using generative AI, despite acknowledging the 'very early stage' of this technological integration and near-term regulatory challenges, which he believes are already priced into current stock valuations. Consequently, Jefferies maintains an optimistic outlook for the sector for the remainder of the year. Specific companies poised to benefit include Amgen (AMGN), which is up 7% this year and actively integrating AI, and software company Schrodinger (SDGR), up 11% this year, which leverages machine learning in drug discovery. Conversely, Illumina (ILMN) and Danaher (DHR), also identified as potential beneficiaries, are down 38% and 17% year-to-date respectively, illustrating a divergence in current market performance within the AI-related biotech space.

Key Decisions for Investors

• Investors should consider the long-term disruptive potential of generative AI in biotech, potentially re-evaluating sector exposure towards companies actively integrating these technologies, as current market valuations may not fully reflect this upside according to Jefferies.
• Given the varied performance of companies like Amgen and Schrodinger versus Illumina and Danaher, thorough due diligence on individual biotech stocks is crucial, focusing on their specific AI adoption strategies, R&D pipelines, and financial health.
• Recognize that AI's impact on drug discovery is in its nascent stages; therefore, a long-term investment horizon is advisable, coupled with close monitoring of technological advancements, clinical trial outcomes derived from AI, and evolving regulatory landscapes.