Health And Tech In Focus
The Forecasts doesn’t publish sector recommendations.
Why not? Because we prefer to purchase individual stocks rather than sector indexes, and there is no such thing as a perfect sector. No matter how attractive a sector looks, we can always find a few companies we don’t want to own. Thus, no blanket buy recommendations.
However, we do see more to like in some sectors than others. If certain sectors offer an inordinately high number of appealing stocks, we will naturally find more buying opportunities in those sectors. A look at our recommended portfolios — particularly the Focus List — shows what we think about a number of sectors.
Our Focus List overweights the technology and health-care sectors relative to their weight in the S&P 1500 Index. Between them, the two sectors account for seven of the 11 stocks on the list, or nearly 64% of the equity and 43% of the entire portfolio including our 32.5% cash position.
Of course, as the name implies, the Focus List is designed to concentrate on just a few stocks. Diversification is not a priority — the Focus List contains only 11 stocks, representing just five of the 10 market sectors. However, the sector overweights found in the Focus List also crop up in the larger, more diversified Buy List.
While both the health-care and technology sectors contain an unusually large percentage of attractive stocks, don’t just rush out and load up on the sectors. As always, stick to companies with strong Quadrix® scores, modest valuations, and the potential to exceed Wall Street expectations. Four such stocks are discussed in the following paragraphs. For another take on how to play top sectors, check out the mutual-fund story of today’s Forecasts.
Takeover rumors have helped lift Biogen Idec’s ($51; BIIB) shares. CEO James Mullen denies any merger talks, but it is easy to see why Biogen would make an attractive target. The biotech firm invests heavily in its product pipeline without straining its balance sheet. Spending on research and development, up 16% in 2008, represents more than one-fourth of sales. Cash holdings of $4.76 per share exceed total debt, and free cash flow — cash flow after dividends and capital expenditures — nearly doubled to $4.43 per share in 2008.
Biogen’s growth prospects depend heavily on multiple sclerosis drug Tysabri. Multiple sclerosis symptoms apparently return soon after patients suspend treatment, making a compelling case against drug holidays, which became popular last year after a small number of Tysabri patients contracted a dangerous brain virus. Physician confidence in Tysabri is returning to levels seen before last summer’s scare. According to surveys cited by Biogen, only 3% of doctors plan to decrease Tysabri prescriptions in the next six months, versus 74% who expect to increase their use.
Moreover, Tysabri’s risks seem to be reflected in Biogen shares, which trade at less than 13 times expected 2009 earnings, cheap considering the company’s growth potential. Per-share profits are expected to rise 22% in the March quarter and 11% for the year. Biogen, a Focus List Buy and a Long-Term Buy, was expected to release March-quarter results April 16.
Johnson & Johnson’s ($51; JNJ) broad sales base should blunt the downturn’s sharpest blows. While the weak economy weighs on consumer products and pharmaceutical sales slump, medical devices should see modest gains because of new products and greater penetration of overseas markets. J&J could tap additional growth from its shift into cosmetics and biosurgical items.
In the March quarter, J&J’s profits were flat at $1.26 per share, beating the consensus by $0.04. J&J trimmed costs to offset sales that fell 7% to $15.03 billion, a 1% decline in constant currency. Pharmaceutical revenue dropped 10% as generic competition cut into sales for antipsychotic drug Risperdal.
Possibly contributing to future growth are seven new drugs up for federal approval this year, including two with decisions expected by May. In March, an FDA panel backed rivaroxaban, which helps prevent blood clots after joint-replacement surgery. In late-stage trials, golimumab has improved mobility and quality of life for patients with rheumatoid arthritis. Both drugs have the potential of reaching at least $1 billion in annual sales.
J&J boasts a robust balance sheet and stellar long-term growth record. Operating cash flow of $14.97 billion in 2008 covered dividend payments nearly three times over. The company has boosted the payout for 46 consecutive years, and another hike this year seems likely. J&J typically raises its quarterly dividend in the June quarter. J&J is a Focus List Buy and a Long-Term Buy.
Dolby Laboratories ($34; DLB) provides encoding technology for the soundtracks of most major films. Both DVD and Blu-ray players use Dolby’s technology, as do many personal computers (PCs). Although PC sales have dipped during the recession, Blu-ray seems to be gaining a foothold in living rooms. Building on 2008’s revenue of $255 million, sales of Blu-ray players could triple this year and top $6 billion by 2013.
As seen with DVDs and now Blu-ray, Dolby’s growth hinges on its ability to adapt to new markets and products — something the company has done very well in recent years. Dolby outfits theaters with digital equipment, including some with 3-D capabilities. Several animated 3-D movies are hitting theaters this year, and Dreamworks Animation has committed to releasing all its films in 3-D.
The company’s reliance on consumer spending has not hurt it despite the recession. Over the last year, Dolby shares rose 2%, in contrast to declines of at least 26% in the S&P 1500 Index and its technology and consumer-discretionary sectors. Dolby enjoys strong fundamentals and operating momentum and seems capable of topping consensus estimates. In fiscal 2009 ending in September, Wall Street projects per-share profits will rise 3% on 5% higher sales. Dolby is a Focus List Buy.
IBM ($99; IBM) withdrew a $7 billion bid to acquire Sun Microsystems ($6; JAVA) after conflicts arose over pricing and antitrust issues. The deal would have fortified IBM’s position in the server market, though IBM’s acquisition strategy generally focuses on the higher-margin areas of services and software.
The hardware business (18% of 2008 sales) could be slowed by the economic slump this year, and rival Accenture’s ($28; ACN) profit warning could presage trouble for IBM’s services unit (55%). However, IBM shares rebounded quickly after falling on the Accenture news, and consensus 2009 profit estimates have remained roughly stable.
Investors could be encouraged by management’s cost controls, growth potential in emerging markets, and aggressive share buybacks (share count declined nearly 5% in 2008). Moreover, recent acquisitions folded into the software unit (22% of sales) could drive modest growth this year. Consensus estimates predict 2009 per-share profits will climb 1% to $9.04, while the company expects at least $9.20. IBM, slated to release March-quarter results April 20, is a Focus List Buy and a Long-Term Buy.