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Regeneron Pharmaceuticals Inc., which develops medicines, has risen from a penny stock in 2010 to $370 (U.S.), yet earnings growth has managed to keep pace.
Regeneron Pharmaceuticals Inc., which develops medicines, has risen from a penny stock in 2010 to $370 (U.S.), yet earnings growth has managed to keep pace.

ADVISOR CORNER

U.S. health-care stocks looking ruddy Add to ...

A decade of political uncertainty over health-care policy in the United States has come full circle.

The Republican sweep to power in Washington on the promise to repeal and replace President Barack Obama’s Affordable Care Act has fallen flat, returning the issue to political limbo.

The U.S. is by far the world’s largest health-care market, but for investors little has changed over the years: It has been a gold mine all along.

Since the Affordable Care Act, known as Obamacare, was signed into law in 2010 the S&P 500 Health Care Index has more than doubled in value. The biotech-heavy Nasdaq Health Care Index has nearly tripled over the same time span.

“There were some favourable elements to repeal, but generally it was more of a worry for health-care investors than anything else,” says John Sullivan, managing director at Leerink Partners LLC, a Boston-based health-care investment bank.

“Today the uncertainty is slowly but surely becoming resolution. I don’t anticipate that another try at repeal and replace will be seen by this Congress.”

The health-care rally has been on pause over the past year as the political debate climaxed. Mr. Sullivan sees the lull as an opportunity to shop for bargains.

“Since the repeal effort failed, health-care investors are much less distracted and seem to be getting back to making investment decisions about individual companies in the sector,” he says.

Politics aside, the main fundamentals driving the health-care sector remain demographics, as baby boomers age, and rapid advances in technology. Unlike most sectors, health care has many diverse subsectors, including pharmaceuticals, insurance, managed care, biotechnology and medical devices.

In a sector that can carry high stock valuations, Mr. Sullivan singles out two large biotech stocks he says are well priced. Regeneron Pharmaceuticals Inc. develops medicines; it has risen from a penny stock in 2010 to $370 (U.S.), yet earnings growth has managed to keep pace. Its stock trades at only 47 times the past year’s earnings.

Alexion Pharmaceuticals Inc., which specializes in therapeutic products, has risen 380 per cent in value since 2010 and trades at 65 times trailing earnings.

Mr. Sullivan says many promising small biotech companies are advancing their products through clinical testing, including the cancer drug developer Seattle Genetics Inc. Its stock has more than doubled since early 2016.

“The level of innovation in the health-care sector has not abated – in the biotech sector specifically,” he says.

He also sees potential in other biotechs, including Exelixis Inc. and Incyte Corp. “We like companies that can either continue to commercialize their products or be subject to favourable acquisitions.”

Success in biotech, however, depends on the ability to earn regulatory approval through the U.S. Food and Drug Administration, which, as a government agency, is influenced by politics. “We’re going to have to wait and see exactly what the guidance is for the new leadership of the FDA,” says Mr. Sullivan.

One health-care subsector he considers more reliable is managed health care. He expects companies such as Humana Inc., which has more than quadrupled in value since 2010, will outperform rivals if parts of Obamacare are repealed.

“The managed-care sector has a lot of opportunity. I think some of the burdens of Obamacare are slowly but surely being unwound as a practical matter,” he says.

He says growth in managed care will also benefit from a strengthening economy. “Employment continues to grow in this country, so more employees are getting rolled into health plans.”

John Nolan manages a portfolio for New Jersey-based WBB Asset Management, which focuses on biotechnology and pharmaceuticals. He also has a positive outlook for the health-care sector but doesn’t expect the political turmoil to subside for long. “You’re going to see an uptick in volatility,” he says.

He expects profit margins for pharmaceutical companies to come under pressure as public support for drug-price controls intensifies. “I believe that because it is such a populist topic you still have the very real possibility of getting regulation concerning price controls for pharmaceuticals.”

For that reason he is focusing on low-cost drug makers. “We believe there is a place for generics particularly because of the conversation around drug pricing. It is going to play an increasingly important part of health care,” he says.

One of his top pharma picks is Teva Pharmaceutical Industries Ltd. Teva’s stock price has been slashed in half since 2016 after a series of legal and financial blunders, but with a forward price-to-earnings ratio of 6.7 and a dividend yield of more than 4 per cent, he considers it a bargain.

“Teva has certainly been beaten up over the past year and a half, but their generic portfolio is really best in class in terms of breadth of product and quality of what they produce. We think there’s a really good valuation opportunity,” he says.

Mr. Nolan’s focus on returns brings a specialization in smaller biotech companies. He says they are fairly immune to politics directly but could be vulnerable to higher interest rates.

“Higher interest rates are often bad for the smaller biotech companies because it raises their costs of debt. It makes it a little bit harder to innovate,” he says.

In keeping with his low-cost theme, one small biotech company in his portfolio is Esperion Therapeutics Inc., which is up more than 200 per cent this year.

Espirion is working on a cholesterol-lowering drug for patients who are intolerant to conventional treatment. Similar drugs must be administered intravenously and cost about $14,000 a year. The Espirion drug can be taken orally and is expected to cost only $3,000 a year.

“We like companies that fit certain themes, like ultimately saving the system money,” he says.

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