McMurtry Investment Report & Model Portfolios

McMurtry Investment Report Newsletter – May 2019

May 2019 – Healthcare Stocks – Are these companies good long term investments?

As of the end of April the US Healthcare stocks represented 13.6% of the S&P 500 Index, while in Canada the weight was only 2.2% of the TSX Composite. This group is the second largest US sector after Technology in terms of market weight. In Canada this group is the smallest sector of the market and is mainly represented by cannabis stocks.

 

The top 20 US healthcare stocks represent more than 72% of the 13.6% equity sector weight, indicating that this sector is dominated by large companies.

 

Currently my sample portfolios have no cannabis exposure due to their overvaluation and lack of real earnings. Therefore, I will be concentrating exclusively on the US for my stock exposure.

 

The US healthcare sector is divided into different groups as follows:

 

Large Pharma
Biotechnology
Medical Devices and Hospital Supplies
Drug Stores
Pharmacy Benefit Managers
Medical Insurance
Hospital Management

 

Large Pharma companies include Merck, Pfizer and Eli Lilly. Not only is this sub sector affected by ongoing political talks about reducing drug prices, these companies also face patent expirations and FDA scrutiny regarding efficacy and side effects from certain medications. Lower priced generic competitors pose a real threat as well.

 

The same is true for the biotechnology companies. However, most biotech companies have a much less diverse drug pipeline and are more exposed to the success of one or two drugs. Companies in this group include Amgen, Biogen, Gilead and Abbvie.

 

The Medical Device and Hospital Supply group is a large component of the healthcare index. Companies in this group include Johnson & Johnson, Abbott Labs, Medtronic, Zimmer Biomet, Stryker, Thermo Fisher, Danaher and Becton Dickinson. Despite Johnson & Johnson’s recent issues with certain products, this group is less exposed to ongoing discussions around drug pricing and the possibility of the implementation of universal health care.

 

Drug store companies include CVS and Walgreens. Both these companies have exposure to the Pharmacy Benefit Manager business which is facing drug rebate headwinds in addition to drug pricing issues. CVS has also purchased Aetna, a major healthcare medical insurance provider.
Pharmacy Benefit Managers include companies like Amerisource Bergen whose business is aligned with Walgreens. As previously indicated, CVS owns a Pharmacy Benefit Manager.

 

Medical Insurance companies include Cigna and Aetna, now owned by CVS. United Health Care is the largest US medical insurance provider. While the overall profitability of this group remains solid, as shown by UNH’s recent quarter, the political threat of Universal Health Care proposed by Bernie Saunders is creating a lot of uncertainty in the share prices of these companies.

 

Lastly the hospital companies include HCA. This group is also facing headwinds by the threat of Universal Health Care proposed by the Democrats.

Industry and Political Uncertainty

Both Bernie Saunders and many other Democrats are proposing Universal Health Care, comparable to what we have domestically and in Europe. The Democrats are furious about what Trump and the Republicans have done to try and totally reverse Obamacare which had helped to insure over thirty million previously uninsured US citizens.

 

It is difficult for many Canadians to comprehend why the US is not endorsing the Canadian system for healthcare. However, it is really important to fully understand the powerful lobbying going on by the medical insurance and drug companies pleading with the Republicans that a single payer system would not be in the best interests of these corporations. Taking away the profit incentive for this industry is just inconceivable for many Americans.

 

The year over year annual cost of healthcare in the US continues to exceed most global countries including Canada. This is principally a result of the refusal of the Americans to endorse Universal Health Care where profit is secondary to coverage for all.

 

This ongoing issue of high drug prices continues to provide a major headwind for the pharma and biotech industries.

Conclusion and Recommendation

The share prices of this group have sharply underperformed the overall market year to date by rising only 4.6% on a total return basis relative to the strong 18.2% performance of the S&P 500 index.

 

Last year this group outperformed the index by rising over 6% compared to the overall market’s decline of almost 5%. This group is considered more defensive relative to the faster growing technology stocks.

 

The ongoing political uncertainty in regards to drug pricing and the threat of Universal Health Care will most likely continue until the US federal election in 2020.

 

Personally, I do not believe the US will endorse a total Universal Healthcare system. Even if the Democrats are elected it will be very difficult to implement unless they control both the Senate and the House of Representatives. Obama was only able to implement a partial plan as the Democrats did not control both houses of government during Obama’s second term.

 

Taking all these factors into account, I am maintaining my North American benchmark market weight of 8.47% for this sector. But it is still important to point out that this is considerably below the US S&P 500 weight of 13.6% by including Canada in the overall sector weight.

 

I continue to favour companies like Merck, Abbott Labs, Thermo Fisher, Danaher, Becton Dickinson and United Healthcare. The average expected EPS growth for these six companies between 2021 and 2018 is 24.6%, with the lowest one being Thermo Fisher at 21.5%.

 

The Swiss dental implant company, Straumann, continues to report strong revenue growth in this expanding industry sub sector with only a handful of global players.

 

Peter McMurtry, BCom, CFA
Financial Writer
Objective Investment Advice for Everyone
Monthly Investment Newsletter and Sample Portfolios
Personalized Portfolio Reviews
https://mcmurtryinvestmentreport.ca

Please see our disclaimer at mcmurtryinvestmentreport.ca.

Copyright © McMurtry Investment Report™. All rights reserved.

mcmurtryinvestmentreport.ca

Strategies for do-it-yourself investors

Peter McMurtry’s latest book
book