A Bunch of Hot Health Care Stocks
Lee is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Sometimes successful investment themes seem to creep up unnoticed to most investors and only after the event do we realize that they were staring us in the face all along. One such idea is the specialty pharmaceutical sector. By this I mean generics, over the counter (OTC) manufacturers and generally those companies outside of the mainstream pharma and biotech sector. This sector has done very well this year and this article will briefly mention some names for investors to do more research.
Why this Theme is Working this Year
Everyone loves the demographics behind the healthcare sector but does everyone enjoy the pressures on big pharma? If it isn’t the patent cliff, it is increased reimbursement pressures or general Government austerity measures putting pressure on pricing. The FDA is getting increasingly tough on approvals and marketing costs are going up. So what is an investor to do?
I think the solution is to focus on health care companies whose offering provides demonstrable cost savings and/or is actually part of the drive to reduce expenditures. I’m talking about things like generics where, for example, the Europeans are trying to reach the kind of penetration levels that the US has. I also refer to companies that manufacture private label and OTC drugs or who have revenues largely unexposed to reimbursement issues. In addition, in an uncertain environment these types of stocks will get bid up as investors gradually wake up to the story.
The first idea I like is dentistry. More older people in general are a good thing for dentistry. More older people with more surviving teeth per mouth are even better! The sector is largely devoid of reimbursement issues and offers good long term growth. I’ve written extensively about Sirona Dental Systems in an article linked here and I think its world leading proprietary system for carrying same day restorations (CEREC) has great long term potential. I’m genuinely baffled by how little interest there seems to be in this company but who cares? Discerning investors would have enjoyed a 21% gain this year.
It’s a similar story with something like Align Technology and its Invisalign invisible brace which is up 49% this year. Growth and technology investing doesn’t always have to be in cyclical sectors like semiconductors or telecommunications.
Everybody wants more drugs but wants to pay less for them. One solution is for the pharmacies and drug retailers to increase their in store private label OTC sales. This would have the benefit of lowering costs to the consumer and since these products tend to come with higher margin to the retailer (compared to brand drugs) it’s easy to see why they are keen to expand them. I like CVS (NYSE: CVS) in this space and have covered them in an article linked here. I prefer CVS to Walgreens for three reasons. Firstly, I like the plan to increase its private label sales. Secondly, I think it can play catch-up to Walgreens in terms of operational metrics. And lastly, I think investors may be underestimating the amount of customers it can keep from those it took during the Walgreens/Express Scripts denouement.
While everyone is crying over lost Government spending revenues, the generics are gearing up for increased growth. That said I think investors need to be a bit discerning here because the sector is a mixed bag. The four big names always quoted are Teva Pharmaceutical, Mylan Inc (NASDAQ: MYL) , Watson Pharma (NYSE: ACT) and Sandoz (Novartis). I’ve held Watson and Mylan this year. I sold out of both because they hit my price targets but I think Watson deserves a closer look now that earnings have been exceeding expectations. It is a huge cash flow generator. As for Mylan, my opinion is that it is a good company but it warrants a decent margin of safety. The management is excited about its opportunities to get a generic version of Advair (Asthma) onto the market and is baking in some assumptions into its earnings targets.
I’m not so sure. I hold a position in a cash rich, program heavy, small cap UK pulmonary drug delivery company called Vectura which is widely believed to be developing a generic version of Advair in its VR315 program. Vectura are developing VR315 with Sandoz in Europe and analysts see it being in the European market in 2013-14. However, in the US, Sandoz returned the rights to Vectura in 2010 and, this should be seen as a warning that the regulatory and competitive environment is likely to be tough in the US. Vectura has subsequently agreed another partnership with a US pharma co for VR315 in the States but Sandoz really was the ideal partner. Analysts expect a 2015-16 launch but I’ve seen estimations for probability for this as low as 19%. The fact that Sandoz walked away from VR315 in the US suggests it wasn’t that confident about getting approval.
Investors willing to look at European small caps might also look at Germany company Morphosys which is cash rich, has a strong partnered program and offers growth prospects through helping pharma reduce development costs..
Specialty Pharma and an Acquisition Target
Within specialty pharma I like Valeant Pharmaceuticals (NYSE: VRX) and Endo Heath Solutions. The market loved the proposed takeover of Medicis because it increased its exposure to dermatology and aesthetics, two segments of health care that are not exposed to public sector cutbacks. In fact, Valeant’s product portfolio mainly involves neurology, dermatology and ophthalmic along with a whole host of consumer and generic brands. The usual criticism of Valeant is that it is mainly acquisition led growth which tends to unravel at some point and the company is building up debt. However, what else should a company be doing with low interest rates? Furthermore, the company is forecasting $1.4bn in adjusted operating cash flow for this year. With a current market cap of around $18bn, the acquisitions are not stretching the balance sheet in my opinion.
The last stock worthy of a mention is Vertex Pharmaceuticals (NASDAQ: VRTX). The unique thing about this company is its pipeline and its market cap of $11bn places it firmly in the camp of mid-cap names that would give a big pharma company immediate growth. Moreover its strength in cystic fibrosis and Hepatitis C will allow a large company to add a product to its own stable of treatments with these indications.
SaintGermain has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Vertex Pharmaceuticals. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.