So far this year, the S&P 500 has returned about 3%. Surprisingly and uncharacteristically, the healthcare sector has fallen 7%, which qualifies it as the worst performer this year.
Theories abound to explain this underperformance. Rising interest rates have resulted in a decline in companies with above-average dividend yields. Many healthcare names, including drug makers in particular, sport relatively high payout ratios. Healthcare has also been rallying ever since new regulations have allowed millions of new patients to enter the marketplace, suggesting it was due for a breather.
Consumers and politicians are also up in arms over what they see as high and increasing drug costs. The truth is that only a few industry players have abused the pricing power that patent protection affords them, but that hasn’t slowed an overall negative attitude to many drugs that help save and improve lives.
Below are three stocks that qualify as beaten-down and are worth a close look by investors interested in recovery potential.
Healthcare Stocks to Buy: Allergan (AGN)
Allergan Plc’s (NYSE:AGN) flagship product is Botox, which is used primarily for cosmetic purposes but also has some medical benefits. Time appears to be proving that it is far from just injecting poison into your body to look better, and the fact it doesn’t have any real competition has meant healthy shareholder returns.
Allergan’s share price has trounced the overall stock market since 2011, but is down over 36% so far this year. It also stands about 38% below its high of $322, reached about a year ago.
There really isn’t a solid explanation for why Allergan’s stock has fallen off its highs. It reported modest sales growth of 1.5% to $3.7 billion during its second-quarter earnings release in early August.
Reported profits were anything but — the company reported a loss of $500 million. But there has been some flux since management decided to sell its generic drug business to Teva Pharmaceutical Industries Ltd (ADR) (NYSE:TEVA) and take a few other charges. Cash flow generation appeared much stronger at $1.4 billion.
Right now, analysts expect earnings per share of almost $14 this year and a jump to nearly $17 in 2017. That suggests a forward price-to-earnings ratio of around 12, or well below the market average of closer to 19.
Allergan, a large and diversified drug firm, should log total sales of $15 billion this year. Botox is its biggest seller, but other big sellers include Restasis, Namenda and Bystolic. The pipeline is also quite healthy.
Healthcare Stocks to Buy: Zimmer Biomet (ZBH)
In 2015, rivals Zimmer and Biomet merged to form Zimmer Biomet Holdings Inc (NYSE:ZBH), one of the largest sellers of medical devices on the planet. Based on second-quarter results reported this week, combining both firms isn’t going quite as well as expected.
Management blamed supply chain problems for cutting its full-year guidance and a weak third quarter. The stock fell 13% following the second-quarter earnings release and now stands nearly 23% below its highest level over the last 52 weeks.
Second-quarter sales rose a very respectable 4% to $1.8 billion and adjusted earnings improved 9%, but the company cut its full-year earnings guidance to a range of $7.90 to $7.95 per share.
Previous guidance was $7.90 to $8 per share, or only a nickel above the new guidance. Regardless, the market punished the stock.
That puts the forward P/E at 12, again well below the market multiple. Archival Stryker Corporation (NYSE:SYK) trades at a much higher forward P/E of 18. Both should grow at similar levels to further suggest that Zimmer’s share price is unnecessarily beaten down right now.
Healthcare Stocks to Buy: McKesson (MCK)
McKesson Corporation (NYSE:MCK) reported second-quarter earnings last week that sent investors scrambling for the sidelines. The stock, which was already trading at an appealing valuation, fell 23% the day of the release.
The stock has since recovered a little to $136 per share, but is down 31% so far in 2016.
Second-quarter earnings fell a rather modest 7% to $2.94 per diluted share, though they fell nearly 50% on a reported basis. The difference was due to a noncash charge that looked to be a one-time deal — many companies these days tend to try and steer investors away from bad news by “adjusting” the profits they report.
Sales for the quarter grew a respectable 2% to $50 billion.
The market reaction was from management lowering its guidance for next year. It now expects earnings in a range of $12.35 to $12.85 per share, which was down around $1 from previous guidance. This also excludes the full-year impact of the goodwill noncash charge and some smaller cost-cutting moves (which it arguably shouldn’t be backing out from earnings).
Overall, any bad news from the decline in profits looks to be priced into the stock. The forward P/E has fallen to 10, or nearly half the earnings multiple for the market as a whole. McKesson has historically traded at a premium P/E to the market.
Near term, because the public and politicians are after drug companies, drug prices are under pressure. McKesson, which distributes drugs, earns some profits from the inflation in prices. That and competition appear to be hurting the stock.
But the company remains a large drug distributors and increased earnings around 15% annually over the past decade. Given its strong track record, the stock looks like a good deal right now.
As of this writing, Ryan Fuhrmann did not hold a position in any of the aforementioned securities.
