Four healthcare stocks to participate in the sector's recovery

Downturn over the past year has created attractive valuations.

Vikram Barhat 4 January, 2017 | 6:00PM
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The roller-coaster year that saw many volatile events -- from the Brexit stock market swoon, to U.S. presidential elections, and Donald Trump's ascension to the White House -- ended things on a happy note for the stock market. Most sectors in the U.S. stock market clocked record returns, or at least performed better than they did the year before. The only exception is health care. As an outlier, healthcare was the worst-performing sector.

The S&P 500 Health Care (Sector) Index, which measures the aggregate performance of the 55 U.S. health care stocks included in the S&P 500 Index, lost more than 4% in 2016, staggeringly underperforming the S&P 500's 13.5% gain for the year.

However, this year's downturn in health care has created attractive valuations, carving out a good entry point for stocks pickers. For long-term investors looking for high-quality health care stocks, this may be a good time to consider some buying opportunities with sustainable, multi-year growth prospects.

No matter what happens in the global economy, as part of a non-cyclical sector some of these companies are well-positioned to benefit from increased access to health care and medical needs of the aging baby-boomer population.

Allergan PLC
Ticker AGN
Current yield -
Forward P/E 11.8
Price US$210.01
Fair value US$300
Data as of Jan. 2, 2017

One of the largest specialty pharmaceutical manufacturers,  Allergan (AGN) specializes in aesthetics, ophthalmology, women's health, gastrointestinal and central nervous system products.

The firm has acquired its way to become a major pharmaceutical contender, and continues to deleverage the balance sheet with ample cash to pursue more acquisitions, says a Morningstar report. "Allergan's diverse portfolio of defensible products, broad pipeline and future potential acquisitions will sustain healthy earnings growth," the report says.

Allergan's acquisitions of Warner Chilcott and Forest Labs helped bulk up its portfolio with a significant presence in the primary care markets of women's health, gastrointestinal, urology and central nervous system therapeutics. As well, "Allergan's considerable scale in niche markets of ophthalmology and aesthetics offers a long runway for growth thanks to defensible products (especially Botox) and an attractive pipeline," says Morningstar equity analyst Michael Waterhouse, whose US$300 estimate of the stock's fair value suggests significant upside potential.

The company's sustainable competitive advantage is built on Botox along with "an industry-leading portfolio in the specialty markets of ophthalmology and aesthetics, which enjoy much higher barriers to entry and lower risk of generic competition than most pharmaceutical products," says Waterhouse.

Through product innovation, Allergan is able to maintain pricing and a healthy market share, supplemented by acquisitions and partnerships to enhance the portfolio. With over US$20 billion in cash, "acquisitions should eventually improve growth opportunities and increase product diversification, which helps minimize patent cliff concerns," says Waterhouse, who projects sales to grow from US$15 billion in 2015 to approximately US$20 billion by 2020.

Amgen Inc.
Ticker AMGN
Current yield 2.74%
Forward P/E 12.4
Price US$146.21
Fair value US$194
Data as of Jan. 2, 2017

A leader in biotechnology-based human therapeutics,  Amgen's (AMGN) portfolio includes innovative medicines that exploit advances in cellular and molecular biology to treat critical illnesses.

"Amgen has its roots in providing supportive-care products to kidney disease and cancer patients," says a Morningstar report. "Strong newer blockbusters like Prolia/Xgeva and future blockbuster cholesterol drug Repatha should defend Amgen's wide moat from erosion due to biosimilar and branded competition."

And while Amgen's biologics are not immune from competitive pressures, the company's own large biosimilar pipeline and low manufacturing costs could help counter challenges posed by branded competitors, says Morningstar strategist, Karen Andersen.

As well, the firm has invested heavily in more efficient manufacturing and has initiated a massive cost-cutting program, both leading to margin improvement from 38% in 2013 to 53% in 2019.

"Amgen's improved manufacturing efficiency will not only benefit gross margins, but could also give the firm a cost advantage in the nascent biosimilar market, where it plans to launch five products by 2019," says Anderson, who puts the stock's fair value at US$194, incorporating 1% top-line growth and 3% bottom-line growth through 2020.

She also forecasts biosimilars to rake in US$2.5 billion in 2025 and for sales from Amgen's remaining pipeline to total more than US$2 billion by 2025.

Roche Holding AG ADR
Ticker RHHBY
Current yield 3.57%
Forward P/E 14.1
Price US$28.55
Fair value US$42.50
Data as of Jan. 2, 2017

 Roche (RHHBY) produces a variety of oncology therapies (more than 60% of pharmaceutical sales). The Swiss drugmaker is also a prominent player in the diagnostics market.

"As the market leader in both biotech and diagnostics, this Swiss healthcare giant is in a unique position to guide global health care into a safer, more personalized and more cost-effective endeavour," says a Morningstar report.

Roche's pharmaceutical division boasts best-selling cancer biologics such as Avastin, Rituxan and Herceptin, which continue to grow and gain market share in approved indications and garner widened approval in new indications and emerging markets.

"Roche's biologics focus and innovative pipeline are key to the firm's ability to maintain its wide moat and continue to achieve growth as current blockbusters mature," says Anderson, who forecasts the firm's pharmaceutical division to achieve a 6% top-line compound annual growth rate through 2020.

Three-fourths of Roche's top pharmaceutical sales are from biologics, which provides a cushion against generic competition. The firm's sustainable competitive advantage arises from its status as the leader in oncology therapeutics (30% market share) as well as in vitro diagnostics (20%). The company also has a promising strategy of combining its expertise in both areas to generate a growing personalized medicine pipeline, making use of companion diagnostics, says Anderson. Her fair value estimate for Roche's nonvoting equity securities stands at US$42.50 per American depositary receipt (ADR).

Biomarin Pharmaceutical Inc.
Ticker BMRN
Current yield -
Forward P/E 814.1
Price US$82.84
Fair value US$123
Data as of Jan. 2, 2017

 BioMarin (BMRN) makes and markets therapeutic enzyme products used as therapies to treat extremely rare diseases. The firm's drugs target rare chronic conditions that often require treatment from a very young age, leading to high patient retention rates.

While commercialization and R&D spending could prevent BioMarin from achieving sustainable profitability until 2017, its rare-disease treatments possess profit-generating power, which, coupled with a deep in-house pipeline and the ability to supplement growth with strategic acquisitions, puts the firm in a strong position.

"BioMarin's life-saving therapies may serve only a few thousand patients globally, but with six-figure price tags on most products and high barriers to entry, we see this as a very attractive marketplace," says a Morningstar report.

BioMarin's products qualify for several years of market exclusivity, based on their orphan drug status. One of its products, Aldurazyme, its first drug approved in 2003, has a price tag of US$200,000 and enjoys market monopoly and process patents through 2020.

"BioMarin's approved drugs have been granted orphan-drug status in the United States and European Union, providing them with at least seven and 10 years of market exclusivity, respectively," says Anderson who puts the stock's value at US$123. Notwithstanding the fact that BioMarin is as yet unprofitable, Anderson is "confident in its expanding moat and diverse portfolio and pipeline," and forecasts "the firm to achieve sustainable profitability in 2017."

She projects 26% average annual sales growth over the next five years, driven by the international expansion of its existing products and potential 2017 launches of new drugs.

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About Author

Vikram Barhat

Vikram Barhat  Vikram Barhat is a Toronto-based financial writer specializing in investing, stock markets, personal finance and other areas of the financial services industry. He also writes for CNBC, BBC, The Globe and Mail, and Toronto Star.

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