Three Ways to Invest in Healthcare

09/13/2019 5:00 am EST


Richard Moroney

Editor, Dow Theory Forecasts

The average healthcare stock in the S&P 1500 Index has returned 8% including dividends this year, just below the broad index’s average total return of 9%, explains Richard Moroney, editor of Dow Theory Forecasts.

Political risks continue to weigh on shares of drug companies and health insurers. On average, pharmaceutical stocks are down 7% in 2019, as many Republican and Democratic candidates running for office pledge to lower drug prices and the White House seeks its own strategy on the matter.

For now, drugmakers keep pushing through price hikes. U.S. prescription drug prices climbed 10.5% in the first six months of 2019, versus a 15% increase for the same period last year. On July 1, drugmakers raised list prices on branded and generic drugs an average of 13%.

Risks for health insurers center on proposals for universal Medicare, made by Democrats, and the abolition of the Affordable Care Act, made by Republicans. The “Medicare for all” proposal would create a single government program for everyone, replacing private and employer coverage.

Meanwhile, an effort by Republican lawmakers to strike down the law entirely continues to wind its way through the courts. Eventually, the case will probably reach the U.S. Supreme Court, which upheld ACA in 2012 and again in 2015.

Nevertheless, the S&P 1500 healthcare sector enjoys a remarkably consistent track record for producing gains. Just three times in the past 25 years did it suffer an annual decline: (drops of 2% in 1994, 14% in 2002, and 26% in 2008). That’s fewer than any of the other sectors in the index during this 25-year span.

While the frequency of the health-care sector outperforming the broad index seems modest — 13 of the past 25 years — its annualized return of 15.5% tops all other sectors. Technology ranks second at 13.3%, while the broad S&P 1500 managed 11.9%. We review three of our favorite health stocks below.

Centene (CNC) shares have slumped 21% this year, hurt by investor ambivalence over the insurer’s plan to acquire rival WellCare Health Plans (WCG) and questions about the fate of the Affordable Care Act.

Reflecting these concerns, Centene shares trade at just 11 times trailing earnings, near their lowest level since 2010 and well below an average of 20 for S&P 1500 Index health insurers.

Nevertheless, Centene’s biggest source of growth has come from the state and federal marketplaces, abandoned by many of the largest insurers. Centene says membership from the ACA marketplaces (13% of its members) grew 27% in the June quarter, while Medicaid Expansion (9%) increased 19%.

Centene’s three biggest businesses remain Medicaid (56% of total membership), commercial plans (16%), and Tricare for military members and veterans (22%). The Medicaid and commercial unit grew membership 18% and 19% respectively in the June quarter, while Tricare held flat. Centene is a Long-Term Buy.

Weakness hitting drugmakers has left no mark on ICON (ICLR), a contract-research organization that helps its clients develop new drugs. ICON is gaining market share as drugmakers move work toward larger CROs.

ICON is also reducing reliance on its biggest customer, Pfizer (PFE), projected to represent 11% to 13% of sales this year, versus 18% in 2017. In the June quarter, ICON’s backlog grew 11% to $8.2 billion, roughly three times annual sales.

The shares have rallied 19% this year, outpacing the 9% advance by the average S&P 1500 stock. Nobody will confuse ICON with a cheap stock — its Quadrix Value score, currently 32, has bounced between 25 and 40 over the past 12 months.

But the trailing P/E of 24 is below the life-sciences industry average of 28. So is ICON’s estimated 2019 P/E of 22, versus an industry average of 27. Encouragingly, ICON shares have held up well since July, slipping just 1%, while the average S&P 1500 stock fell 8%. ICON is a Long-Term Buy.

Thermo Fisher Scientific (TMO) shares are expensive relative to the broad market (Quadrix Value score is 36), a valuation that reflects excellent operating growth. For the 12 months ended June, Thermo Fisher grew earnings per share 13%, revenue 8%, and cash from operations 15%.

Although quarterly cash-flow growth can be sporadic, the company has reeled off 15 straight quarters of higher sales and 40 consecutive quarters of higher per-share profits.

Thermo boasts a fairly stable business model, selling medical instruments and equipment to drug companies, hospitals, research institutions, and government agencies.

Looking ahead, Thermo Fisher is expected to increase per-share profits 10% in the September quarter, 8% in the December quarter, and 11% in 2020. Quarterly sales growth should be in the range of 5% to 6% through 2020. Management has topped both profit and revenue estimates in each of the past 10 quarters. Thermo Fisher, yielding 0.3%, is a Long-Term Buy.

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