By Stephen Leeb
The Complete Investor
Spending less but feeling better? Feeling better because you're spending less? The septet of well-managed companies featured below do all things that can improve Americans' health and quality of life while keeping costs down.
With a nod to the new health care reform law, we set ourselves a challenging task: to find companies that upgrade our quality of life by making us feel better or healthier without cutting deeply into our disposable income, which hurt our quality of life. Making the quest even more difficult was that our choices needed to meet some strict investment criteria.
Here's what we were at: a host of statistics suggests Americans' material well-being has slipped. Cars and homes, for instance, have been getting smaller, while education and entertainment cost more. The real median household income has been declining. It was lower in 2008 than a decade earlier, and while not all the figures are in for 2009, it looks as if the decline has continued. This constriction on income, you could argue, makes good health and overall physical well-being worth more to an individual than ever.
So we looked for companies who products and services make life better - particularly by improving physical health - without further compromising individuals' ability to afford material goods. And we were delighted to find a handful of strong companies that did not only offer the potential for a happier, healthier life but that by reducing health care costs can potentially add to real incomes. Companies with these powerful positives will have a natural ability to generate earnings growth over the longer term.
As always, though, we also insisted that our picks have a dominant or at least very strong position in their industry. And finally we wanted stocks that on average have PEG ratios (our favorite measure of valuation) below that of the S&P 500, ensuring they're not too richly valued.
The following seven stocks fit this demanding bill: Amylin Pharmaceuticals, McKesson, Medtronic, Odyssey HealthCare, Teva Pharmaceutical, Universal Health Services, and WebMD Health.
The most speculative is Amylin Pharmaceuticals (AMLN: $22.71), the leading manufacturer of incretins, hormones that can ease virtually all the symptoms of diabetes 2, a disease that by some estimates costs the country billions of dollars a year. (Amylin is a longtime member of our Fast Track Portfolio). The biggest drawback to the medication, Exenatide, is that it requires twice-daily injections, which is why it hasn't won wide acceptance despite its superior results. But Amylin has developed a once-a-week version, Exenatide LAR, that's even more effective than the original formulation: it controls blood sugar better while lowering cholesterol, blood pressure, and body mass. Various issues that have delayed FDA approval appear to have been resolved. The drug's potential is enormous both for sufferers from the disease and for society as a whole, which would realize immense cost savings.
Medtronic (MDT: $45.71) is the world's largest manufacturer of medical devices. Though best known for its stents and valves that are used to alleviate cardiovascular symptoms, these heart-related implants account for just around half of the company's revenues. The remaining 50 percent come from implants that ease chronic conditions ranging from diabetes to spinal injuries to a variety of neurological disorders, including psychiatric disorders such as severe obsessive compulsive behavior, dystonia (associated with Parkinson's disease and other chronic disorders), and chronic severe pain. Arguably no other company has a product line that does more to improve quality of life over such a wide spectrum of chronic disorders. And by improving the well-being of such a diverse range of patients, the company is also boosting societal productivity.
Medtronic has more than 15 consecutive years of profit gains, while its rock solid balance sheet and a free cash flow yield of over 8 percent explain why 2008-09 didn't challenge it financially. Going forward we expect growth to approach the mid-teens (compared with Wall Street estimates of 12 percent) largely on the growing strength of deep brain stimulation (DBS), the technique used to treat formerly intractable neurophysiologic disorders. Medtronic is the only approved provider of DBS. The stock should significantly outperform the market in the years ahead.
One of the most difficult health care questions is how heroic and expensive end-of-life measures should be. Drugs like Avastin, for instance, used in a variety of terminal cancers, can sometimes extend life by a year or more, but the average extra survival time gained is closer to two to five months. These extra few months are often very painful ones - and costly. A single dose of Avastin can cost over $50 thousand, which doesn't count the additional very expensive medical care required. More generally, last-year-of-life expenses average an estimated $25 thousand, or about 30 percent of the Medicare budget. The last month of life consumes some 10 percent of the Medicare budget.
One alternative to heroic measures to extend life is hospices. Rather than attempting to extend life, hospices try to make the last months of life as comfortable and pain-free as possible, and many scientific studies confirm that they do offer a higher-quality end-of-life level of care. With the fragmented hospice industry, Odyssey Healthcare (ODSY: $18.87) is the largest pure-play public company. The company features a strong growth record and a superb balance sheet along with high free cash flow, making acquisitions feasible. We expect organic growth combined with acquisitions to result in long-term growth in the mid-teens. This well-managed company should solidly outperform the S&P 500 for the foreseeable future.
While we don't have precise data, there's strong evidence that many Americans who have been uninsured have psychiatric problems. One data point is that 15 percent of branded drug sales are psycho-pharmaceuticals. Psychiatric problems have often been deemed a preexisting condition and used to deny an individual insurance. They also are proportionally more prevalent among the poor, who generally have been less likely to have insurance. Thus while all hospitals should benefit from the additional patients result from health insurance, hospitals specializing in psychiatric and behavioral disorders may benefit the most. Of the major publicly traded hospital companies, Universal Health Sciences (UHS: $35.45) has the largest dedicated psychiatric facilities. The company will also benefit from the likely comeback of Las Vegas, where it has the largest concentration of hospitals. Weakness in Las Vegas will likely mean just single-digit growth in 2010. But there after the company should be firing on all cylinders with low to mid-teen growth likely. This is an undervalued stock that offers superb long-term potential.
By a wide margin WebMD Health (WBMD: $50.40) is the largest dedicated health care Internet portal. The company's various sites provide medical information useful to consumers and professionals alike. If you're wondering what to do about a nagging ache, cough, etc., the site can advise you to take an analgesic or direct you to a doctor. The company's potential to cut costs and raise societal well-being is obvious. Traffic to the site has grown strongly in recent years - including during recessionary 2008-09 - and should continue to grow thanks to an aging population and an unexploited international market place. The company's two sources of income are advertising, which should remain sharply uptrended in the years ahead, and fees for professionally sponsored educational Web seminars, which also should continue to grow rapidly. While the stock's P/E is high, the multiple is more than merited in view of the torrid growth prospects and exceptional balance sheet. Buy for strong long-term gains.
Leading the generics field is Growth Portfolio's Teva Pharmaceuticals (TEVA: $62.01). Capitalized at $59 billion and selling some 400 or so different medications, this Israeli company is the world's largest manufacturer and seller of generic drugs, putting it squarely in the sweet spot of health care trends.
Teva's revenues in 2009 were $13.9 billion, while profit topped $3 billion. Management was projecting revenues of $31 billion by 2015 - representing compounded growth above 14 percent a year - and net income of $6.8 billion. These prospects were exciting enough, but now Teva's future has grown brighter still as a result of its March acquisition of Ratiopharm, Germany's second-biggest generic drug maker. The $5 billion purchase puts the company in prime position in Germany - which with $8.8 billon a year in generic drug sales is the world's second largest market - and in Europe as a whole. Before the acquisition, Europe generated less than one-quarter of Teva's total sales, but the continent will become increasing important as a source of growth.
In addition, the acquisition doubles Teva's sales in Canada. It also should lead to significant synergies, with management looking for it to boost earnings starting in the third quarter after the deal's closing (expected by yearend). And with the acquisition funded by cash and lines of credit, Teva remains in fine financial shape. While the shares have rallied on the news, they are still cheap - trading below 13 times expected 2011 earnings and with a PEG below 1 - and Teva remains a core health care holding.
Health care reform will also benefit companies that help move medications, including generics, from manufacturers to consumers. These include pharmacy chains like Walgreens and pharmacy benefit managers (PBMs) like FundFinds' latest pick Medco Health Solutions. Growth Portfolio's CVS Caremark, a unique blend of a pharmacy and a PBM, is likewise a natural beneficiary of rising volumes of prescriptions.
Moving further along the supply chain, higher drug sales will boost revenues of the wholesalers who sell drugs to pharmacies and other distributors. Here the dominant player is San Francisco-based McKesson (MCK: $64.87). It joins Growth Portfolio this issue.
Capitalized at $18 billion, McKesson delivers one-third of all medications sold in North America. It supplies more than 40,000 U.S. pharmacies, including those in Wal-Mart stores and in hospitals along with chains and community drugstores. Its largest customer CVS Caremark, which in fiscal 2009 (ended March 31, 2009) accounted for 14 percent of overall revenues. (CVS Caremark is also a primary customer of one of McKesson's two largest competitors, Cardinal Health). Unfortunately, it second largest customer, at 12 percent of sales, is Rite Aid, which isn't in great shape and represents a potential risk. But this negative is far outweighed by a positive that sets McKesson apart from all its competitors: its technology solutions business.
The division accounted for only 2.8 percent of sales in fiscal 2009, or $3.1 billion of the company's $106.6 billion in revenues - but with gross profit margins of nearly 50 percent, it contributed around one-quarter of companywide profits. By contrast, McKesson's drug distribution business had gross profit margins of only 3.82 percent. And while margins in the distribution area are improving with the growth emphasis on generics, and while expanding volumes of drug sales will certainly help profit growth, it's the technology solutions business that gives McKesson true earnings leverage in the years ahead.
Notably, McKesson's revenues from technology dwarf those of the largest stand-alone health care information technology company, Cerner, which in fiscal 2009 generated $1.7 billion in sales. McKesson's division develops and installs IT systems that streamline health operations in part by eliminating paper prescriptions and health records. Its software and hardware are used in more than 70 percent of U.S. hospitals that have over 200 beds. Sales from the division have grown by more than 66 percent over the last three fiscal years, while operating income from the segment is up almost 80 percent. Sales should ramp up even faster going forward as stimulus money is put to work and health care providers seek to increase efficiency and cut costs.
Rapid growth in this area should help push companywide earnings growth into the low teens. McKesson's shares should reflect this growth as well as get a boost from rising P/Es. The stock currently trades at 14 times forward earning expectations, in line with multiples for drug distributors. The market so far hasn't awarded McKesson any sort of premium for its IT operations, but eventually it should realize a higher multiple is merited.
Editor's Note: Stephen Leeb is editor of The Complete Investor, P.O. Box 248, Williamsport, PA 17703, 1 year, 12 issues, $72. Dr. Leeb, using his two unique key indictors, has predicted nearly every major market movement during the past 30 years. Because of this, he has had the distinction of being named America's #1 market timer by the Timers Digest. He was editor of Personal Finance for 13 years, and is routinely a winner or the runner up for the top NEPA financial journalism awards. He is the author of six best-selling investment books. For more information on The Complete Investor and a Special Offer visit www.completeinvestor.com.
