What's ailing health care?
Longtime health-care investors can be forgiven their confusion.
Drug stocks are supposed to be defensive. But many of the largest drugmakers have been pounded. The S&P 1500 Pharmaceutical Industry Index is down 8% so far this year, versus a 4% decline in the S&P 1500 Health Care Sector Index.
Health-care companies’ profits are supposed to remain fairly steady regardless of the economic situation. But hospitals’ capital spending fell in the December quarter, and many consumers are putting off medical care because they cannot afford it. In addition, the specter of health-care reform has investors worried about future profits.
Fortunately, the news is not all bad. The wind may have shifted, but the boat remains seaworthy.
On the surface, the numbers are ugly — five of the six industry indexes within the S&P 1500 health-care sector have declined over the past 12 months. But all six indexes outperformed the broader S&P 1500.
Defensive is a relative term. And relative to the 44% decline in the S&P 1500 Index over the last year, most health-care stocks were fairly defensive.
Nationwide, health-care spending accounts for 16% of gross domestic product, so the sector remains key to America’s economic well-being. An aging population and other demographic trends favor health-care companies; the Centers for Medicare & Medicaid Services projects national health spending will grow at an average rate of 6.7% through 2017.
The Obama health-care plan promises to cut insurance costs for consumers and make coverage available for those who cannot afford it. The plan calls for limiting the profits of managed-care providers and making it more difficult for drug companies to defend patents. The final version of any legislation is likely to be more business-friendly than the current proposal, but the risks are real.
Reform concerns aside, many health-care companies seem capable of continued growth. The average health-care stock in the S&P 1500 Index earns a Quadrix Overall score of 66, higher than the average for any other sector besides energy. Quadrix scores, growth potential, and value vary widely between different subindustries within the health-care sector, as shown in the table below. This year, consensus estimates project double-digit profit growth from the average biotechnology and health-care services company, with no other group topping 8% growth. However, the market expects a return to broad-based growth in 2010, with all subindustries managing at least a 5% revenue increase and 10% gains in per-share profits.
In the following paragraphs, we review two of our favorite health-care stocks.
AstraZeneca ($35; AZN) was one of the drug industry’s top performers last year, with the shares down just 4%, versus a 21% drop in the S&P 1500 Pharmaceuticals Industry Index. Wall Street expects per-share-profit growth of less than 1% this year, but the consensus has risen 3% over the last month. At just seven times estimated 2009 earnings, AstraZeneca shares trade at a 46% discount to the five-year average forward valuation of 13.
The new year has delivered mixed news for one of AstraZeneca’s key products. A study found that many antipsychotic drugs — including AstraZeneca’s schizophrenia treatment Seroquel (sales of $4.45 billion, or 14% of total revenue in 2008) — pose heart risks. But in January, the Food and Drug Administration granted Seroquel six more months of exclusivity, extending the patent until March 2012.
With more than 30 projects in late-stage clinical trials, AstraZeneca stands poised to reap the rewards of research-and-development spending that represented about 16% of sales over the last six years. AstraZeneca is a Buy and a Long-Term Buy.
In 2008, Johnson & Johnson’s ($55; JNJ) sales grew 4% as gains in consumer products (up 11%) and medical devices (up 6%) offset a 1% decline in drug revenue. This year, expectations are lower, as J&J expects sales flat to down 1% and the consensus projects a 3% decline.
Acquisitions should help support the top line. J&J heightened its presence in emerging markets by picking up Dabao, a Chinese cosmetics maker. The $1.1 billion acquisition of breast-implant maker Mentor in January strengthens J&J’s move into products for cosmetic and reconstructive surgery.
The drug pipeline is promising. J&J filed five new pharmaceutical compounds with the FDA in 2008 and plans to submit several more over the next two years. HIV drug Intelence gained preliminary approval in January under an accelerated review program, and J&J has asked for full approval to market to patients who have stopped responding to other medication. J&J is a Focus List Buy and a Long-Term Buy.
Feds prescribe fiscal fix
The federal government’s stimulus plan should give the health-care industry a booster shot, encouraging more patients to pursue medical treatment. Proposed funding includes:
• $87 billion in federal Medicaid funding for states. Potential beneficiaries: every health-care company we recommend.
• $21 billion to subsidize health insurance for unemployed. Potential beneficiaries: every health-care company we recommend.
• $19 billion in payments to hospitals and physicians for computerizing medical-record systems. Potential beneficiary: Cerner ($38; CERN), rated Best Buy in sister newsletter Upside.