Editor's note: This story was updated September 15.
A thick cloud of political uncertainty has been covering health-care stocks. At the core of the issue: Some reform of the health-care system seems likely, but will the high cost and record federal deficits keep President Obama from getting what he wants? Will some as yet unknown national health-care plan emerge to reengineer the current system?
And the big question for investors: Given such uncertainty, does it make sense to invest in health-care stocks before the dust settles? After all, any reform will likely mean cuts in prices of drugs and other health-care products and services, which would squeeze corporate profits.
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Some smart buys exist, if you pick carefully. Many of the stocks are cheap, and some companies may actually benefit under any scenario. Also, global operators who generate half or more of their revenues from overseas aren't so affected by American health-care politics. Here are six health-care stocks that are reasonable values in this murky environment.
No matter the outcome of reform, generic drugs should benefit. Whether the government, employer or consumer is doing the spending, low-cost generics have an advantage. And over the next five years, $150-billion worth of pharmaceuticals are scheduled to come off patent, which means they're fair game for makers of generic drugs.
That's all good news for Israel-based Teva Pharmaceutical (symbol TEVA), the world's largest generic-drug maker. Standard & Poor's expects Teva, which generates 96% of sales outside its home country, to compound earnings by 17% annually over the next three years. Generics' share of pills is growing nearly everywhere, including key markets such as Japan and Europe. At the September close of $50.78, Teva sells for 15 times estimated 2009 earnings of $3.33 a share.
Teva's largest competitor in generics is Sandoz, a division of Switzerland's Novartis (NVS), which is also a Big Pharma heavyweight. Novartis, which books 70% of sales outside the U.S., has a particularly productive research lab (an impressive 16% of sales are allocated to R&D) and a nicely balanced product lineup that includes vaccines, diagnostics and eye-care products, along with brand-name and generic drugs. The stock of this financially rock-solid company yields 3.6% and, at $47.80, sells for almost 14 times projected 2009 earnings of $3.54 per share.
Perhaps the most diversified company in the industry is venerable Johnson & Johnson (JNJ). With J&J, which generates half of revenues abroad, you get a first-rate business in brand-name consumer products (Band-Aid, Listerine and Tylenol, to name a few) along with the patented drugs, medical devices and other health-care products whose pricing may be affected by health-care reform. J&J is a dividend-growth champ that yields 3.2%. The company is consistent, highly profitable and, at $60.15, sells for just 13 times earnings.
We know that drug makers are already under pressure to cut costs and to expedite the discovery and development of new drugs. Two beneficiaries of this industry trend to outsource are Covance (CVD) and Charles River Laboratories (CRL). Covance, which serves drug makers such as Eli Lilly, provides the laboratory work for one-third of all drug clinical trials worldwide (40% of revenues are from abroad).
Charles River is renowned for its business of breeding rats and mice for research. It produces the best lab rodents and has a 50% global market share in the business (the Food and Drug Administration and many other regulatory agencies require animal testing of drug candidates). Charles River then competes with the likes of Covance in the toxicology stage of drug testing. The stocks of both Covance and Charles River collapsed last fall, ultimately dropping more than 60%. Both have recovered a bit with the market and seem reasonably priced. At $57.55, Covance trades for 21 times 2009 earnings; Charles River, $36.13, trades at 15 times earnings of $2.41 per share.
Finally, we know that the aging and growth of the population means more prescriptions. Sales of generic medicines at drug stores such as CVS (CVS), the industry leader, are as good as -- or better than -- those of higher-priced, brand-name pills. CVS, which dispensed 729 million prescriptions in 2008, has 7,000 stores and opens 250 to 300 new ones each year. Most of the floor space is allocated to general merchandise, such as cosmetics, film processing and candy, but about 68% of the stores' revenues come from the pharmacy. Sales should reach $97 billion this year, and, at $36.44, the stock trades for 14 times the earnings forecast of $2.60 per share.
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