How To Play The Healthcare Sector

The recent volatility from the Healthcare sector has left many investors weary about where to place their money. General market swings aside, M&A activity and legislative developments have intensified the uncertainty in the sector, but have also lead to many investment opportunities.

M&A has been very exciting and has ramped up heavily in the last few months.  Pfizer (PFE) and Wyeth (WYE), Roche and Genentech (DNA), Merck (MRK) and Schering-Plough (SGP), Gilead (GILD) and CV Therapeutics have all hit the headlines.

Obama’s Healthcare Budget Plan has stirred up heavy trading in recent weeks, putting downward pressure on the Managed Care and Pharmaceuticals sectors, while giving a boost to the Generic Drugmakers. The market has rallied in the past week.

Is your portfolio ready for a turn-around? Is small-cap going to outperform on the way up, or large cap? Growth? Value? Well, let me give you a couple of picks within the Healthcare sector that I feel can handle the tension of the market, while also providing unmatched returns.

On a macroeconomic basis, looking at Obama’s Healthcare Budget Plan and worldwide trends, Generics are obviously at the forefront. Should you buy Novartis (NVS) because it has the Sandoz division so you can sweep away the beaten down “Pharma” stock?  Could you run away with these Generic profits, basically killing two birds with one stone? Novartis really hasn’t fared that badly in this market compared to some of its competitors like Merck and Pfizer during the last year or so, but I feel your money is better spent elsewhere.

Teva Pharmaceutical, which I wrote about last week, is a clear winner. Teva (TEVA) has an unmatched reach in the global generics market relative to competitors Mylan and Watson. They have a great acquisition strategy and recently completed the acquisition of the 4th largest generic drugmaker, Barr Pharmaceuticals. Teva has the greatest number of ANDAs (Abbreviated New Drug Applications) and has had great success with Paragraph IV filings, which is not typical of many companies.  As a note, in addition to its growing generic exposure, Teva also manufactures and markets some leading Pharmaceutical drugs: Copaxone for multiple sceloris, Azilect for Parkinson’s disease, and ProAir HFA for asthma.

To touch upon domestic macro trends, President Obama is pushing heavily for the widespread use of biogenerics, or generic forms of biotech drugs. The U.S. is a bit behind the biogenerics curve, since the European Union already approved generic biotech drugs in 2006 (with 11 years of exclusivity for the original branded version), but it is one of Obama’s Healthcare priorities. The bill is also picking up some steam in Congress, despite focus on the financial rescue packages and programs.

The biotech bipartisan bill was introduced last Thursday by Senator Charles Schumer of N.Y. and Susan Collins of Maine. In the bill, they proposed giving biotech drugs five years of exclusivity and up to three more years for modifications. Mark Schoenebaum of Deutsche Bank noted, “From the biotech perspective, this is not a positive development. But I think most of the stakeholders understand there’s going to be a compromise on exclusivity.” Personally, I feel that this will not get passed until 2010, and in no way will the exclusivity period be five years on biotech drugs. Remember, there is a lag with the FDA. They are understaffed and simply do not have the manpower to handle all the incoming applications.

Since the Generic market obviously fits well into the macro approach, what other sub-sectors can you reap benefits from? Well with what I just mentioned, the Pharma/Biotech market does not seem too attractive. But, a company that does have some Pharma/Biotech exposure that I feel worth mentioning is Abbott Laboratories (ABT). Pharmaceuticals made up about 56% of Abbott’s revenues in 2008 led by great sales of Humira. Humira has received FDA approval for six indications:

1. Rheumatoid Arthritis (December 2002)
2. Psoriatic Arthritis (October 2005)
3. Ankylosing Spondylitis (July 2006)
4. Crohn’s Disease (February 2007)
5. Psoriasis (January 2008)
6. Juvenile Idiopathic Arthritis (February 2008)

Humira is currently going for its seventh use for ulcerative colitis, which is in Phase III testing and is expected to be launched in early 2010. In 2008, Humira had sales of $4.5 billion, which was a 48% increase from the prior year.  Furthermore, some analysts have projected Humira sales to reach about $5.6 billion in 2009.

Abbott also has a great Vascular division with its leading Drug Eluting Stent (DES), Xience. It has about 27% U.S. market share, saw worldwide sales of $824 million in 2008, and has projected sales of $1.1 billion in 2009. Another huge development will come from Xience’s expected launch (early 2010) in Japan, where the DES market exceeds $500 million.

Aside from these two products and divisions, ABT has a great array of Diabetes and Lipid management drugs and devices. In addition to that strong portfolio, it just acquired Advanced Medical Optics, for $2.8 billion, or $22 per share. Some key facts about the AMO’s market leadership:

• #1 position for LASIK surgery
• #2 position in cataract surgery
• #3 position in eye care solutions

Although LASIK surgery is somewhat discretionary, the acquisition will be a long-term footprint for ABT and adds diversification to its revenue stream. Healthcare saw JNJ make two acquisitions late last year, and ABT has followed suit and done quite well. Nevertheless, Abbott Laboratories has a great portfolio of drugs, products, and devices to weather any market.

There you have it: two picks, Abbott Laboratories and Teva Pharmaceuticals, that I feel will perform well considering both the sector and macro trends.  The underlying political uncertainties have only added to the volatility and complexity of the sector, but given Teva’s global leadership in the generic market and Abbott’s diversified revenue sources, I think these companies will be steady, bright spots for your portfolio.

Disclosure: The Fund the author is associated with is long ABT, GILD, JNJ, and TEVA.

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