Health care was last year's top sector and now it's one of this year's worst performers. What gives?
If you've got questions about health care, you want to talk with Jordan Schreiber. He has run the (MAHCX Quote - Cramer on MAHCX - Stock Picks)Merrill Lynch Health Care fund for since its inception 18 years ago, making him the most tenured health fund manager around. He didn't keep his job by just chugging along with the crowd, either. Thanks to some savvy stock picking, his fund tops its average peer and the S&P 500 over the past one, three, five and 10 years.
And unlike some sector fund managers, he's not a cheerleader touting everything on his radar screen. After the average health care fund racked up a 55% gain last year, the category is down 18% on average since Jan. 1. He's putting his money in select hospital, HMO and biotech shops this year and steering clear of the pharmaceutical sector, where legislation that would cap drug prices is dragging on share prices.
What's his take on the sector's bellwethers? Where would he put money for five years? Read on.
1. What's the case for investing in health care today? Schreiber: I think there's a case for investing in health care for both value investors and growth investors. Value investors would be looking at pharmaceuticals because their current valuations are historically reasonable. Today they're trading at about a 4% premium [to the market or S&P 500] and [historically] they average about a 20% premium. Their growth is steady, it's consistent and visible. It's a safe haven.
For growth investors, it's a different story. We're growth investors and we've got a list of reasons why not to invest in pharmaceuticals right now. We're not doing it. But growth investors do have opportunities in biotech and service areas. In biotech, the companies are moving rapidly toward commercialization of new products through the sequencing of the [human] genome. Some are close to final studies and some are soon to be approved. So it's very, very exciting. On the service side, with HMOs and hospitals, the numbers are reasonable, and the political pressures have been reduced.
2. Let's drill into health care's major subsectors. Pharmaceutical stocks, for instance, have been hurt by the specter of legislation that will cap drug prices. You think pharma stocks are cheap, but you're not buying. What time frame should someone use if they're investing there today? Schreiber: I'd say several years. Now, on the government price pressures that you mentioned, I don't think anything's going to happen for two years. It's a political issue.
So are pharma stocks in the penalty box for that long? Schreiber: I don't think so. No. 1: If the program that's been spelled out was ever enacted -- and it probably will be in some form -- I think there's a good chance that greater unit volume will overshadow decreased margins, and the industry actually might benefit. No. 2: The program costs more than either party ever dreamed, which makes unlikely passage the way it's been proposed. I don't see that as a negative. I think life will continue as it is and that's not bad. Fundamentals will stay in place and growth rates are continuing.
I think the real problem is that patents are expiring for some companies and some products. Also, the FDA is in somewhat of disarray for several reasons and the approval of new products has slowed. So you have fewer new products and you have some of the old ones falling by the wayside. That's a negative, obviously. That's what discourages me as a growth investor, not the legislation.
3. Where do you see biotech stocks going from here? Some say they're just in the summer doldrums and might see some nice returns in the second half of the year. Schreiber: Well, that's my thought. In the fall you have scientific meetings. That always inspires some interest. There are a lot of studies that are coming to some point of determination. Are they for real? I think many will be. Many are focused on very important therapeutic areas, and they're moving toward commercialization. I do expect an upsurge. It's been quiet.
Healthy Indeed
Schreiber has stayed ahead of his peers |
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| Source: Morningstar. Returns through Aug. 8. |
4. How about the service companies, HMOs and hospitals? Schreiber: I see the growth continuing for the hospitals. Maybe the rural hospitals doing a little better than the urban in terms of performance measures, but I see the whole group continuing to move. And I see the HMOs, once the shape of the Patients' Bill of Rights is clear two months from now, I think they'll resume. I see some significant upside there.
5. What pharmaceutical company has that magic combination of strong science with a solid marketing machine? Schreiber: Well,
Pfizer (PFE Quote - Cramer on PFE - Stock Picks) is probably the best at this moment. But there are possible threats to its major product. But it's still one of the best companies right now.
What are the threats? Schreiber: Lipitor, which is a cholesterol-lowering drug, has about 45% of the market and is a key product for Pfizer. But there are new products coming. There's one that
Astrazeneca(AZN Quote - Cramer on AZN - Stock Picks) has that appears to have better effectiveness, and there's also one in Japan that's in an early stage. I don't mean to be negative, I'm just suggesting that the competitive horizon may be a little tougher looking two, three, four years down the road.
6. When you look at biotech, what company stands out to you as being both innovative and financially stable? Schreiber: I look at biotech as having three major segments. The first is large companies that have products on the market with sales and earnings, where we can look at balance sheets. I think the leader in that category is
Amgen (AMGN Quote - Cramer on AMGN - Stock Picks). The second segment is biotech companies that have one product on the market, or one in advanced clinical development. They have enough money to weather the storm over the next couple of years and their burn rate is under control. There I like companies such as
Medarex (MDX Quote - Cramer on MDX - Stock Picks), which develops antibody-based pharmaceuticals that could help treat cancer, transplant rejection and other problems.
The third class of biotech companies are those that provide enabling technologies, so-called tool-kit companies. There I like
Lexicon Genetics (LEXG Quote - Cramer on LEXG - Stock Picks), which is a small company that has the leading inventory of genetically specialized mouse embryos, which sounds like something way out [laughs]. But this is a key for determining the function of proteins, which is really what the whole genome thing is all about.
A Little Health Can Help
Putting 10% of a diversified portfolio's money in a health care fund can boost returns. |
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| Source: Morningstar. Returns through June 30. |
7. Let's play some word association. I'll name a bellwether, and you let me know if you own it in the fund and what you think of the company. Let's start off with Pfizer. Schreiber: Pfizer just has very steady growth. We do own it. I see it as an ongoing, core holding for the pharma area.
How about Merck (MRK Quote - Cramer on MRK - Stock Picks)? Schreiber: We do not own Merck. I think they have a couple of years before they can revive their pipeline with new drugs and make the organizational changes that are necessary to revitalize the culture of the company. They have a lot of things to do before they can be a sustainable growth company.
Johnson & Johnson (JNJ Quote - Cramer on JNJ - Stock Picks)?
Schreiber: We don't own J&J. I've always felt it was too large, too diversified. It's the safest company, but it's also too broad -- the growth isn't there.
It's almost like a mutual fund in itself. Yes, yes. Things tend to cancel each other out. You have good news in one product and bad news in the other. And you end up with much less than you hope for.
American Home Products (AHP Quote - Cramer on AHP - Stock Picks)? Schreiber: We own it. I think they could be an acquisition target at some point. They have a long list of new drugs. None of them are really powerhouses, but there's enough there to sustain midteens growth for some time. There's new management, which is a ray of sunshine. But they need some new sources of earnings growth.
Amgen and Genentech (DNA Quote - Cramer on DNA - Stock Picks)? Schreiber: We own both Amgen and Genentech. And there are enough sources of growth there to keep going for the next couple of years for both companies. Amgen's our biggest biotech holding. The problem with Genentech is that half the company's owned by
Roche Holdings. And if they could somehow recapture their independence, it'd be a hell of a lot nicer [laughs]. Very able management, good pipeline of new products, well-managed in terms of balancing revenues with expenditures and so on, good marketing. But they are half-owned by Roche, which is a negative.
8. Is there a product or drug out there that is not overly hyped right now that you think is going to be a knockout innovation? Schreiber: We own a drug-delivery company called
Emisphere Technologies (EMIS Quote - Cramer on EMIS - Stock Picks) that has a means of converting injectible drugs for oral delivery. They're working on Insulin, Heparin and a couple of others. I believe the science is correct, I believe what they're doing is right. They've made very slow progress and that's turned a lot of people off. But I think that an oral insulin would have enormous appeal.
9. What could lead to a worst-case scenario for health care going forward in the next couple of years? Schreiber: Aside from political pressures, there's a regulatory risk. The regulatory risk is the Food and Drug Administration. They've slowed down on their approval of new products. I'm told that 30% of the staff would be eligible for retirement in October. There's no commissioner. [Laughs.] It's not a good situation, they're in disarray.
You're not painting a pretty picture there. Schreiber: No, and that's a risk. I may be overstating it, but there has been a slowdown in approvals.
10. In light of their products, management and current valuation, what three companies would you buy today and hold for five years? Schreiber: First I'd say [hospital operator]
HCA(HCA Quote - Cramer on HCA - Stock Picks) at this point, is one of those. So is [HMO]
Wellpoint Health Networks (WLP Quote - Cramer on WLP - Stock Picks) and [hospital operator]
Tenet Healthcare(THC Quote - Cramer on THC - Stock Picks).
In pharma I'd choose Pfizer and in biotech I'd choose Amgen. I'd also choose a drug distributor we own,
Amerisource Health(AAS Quote - Cramer on AAS - Stock Picks) -- well, they have extremely able management -- they're about to acquire
Bergen Brunswig in a deal that closes in three weeks. That'll damn near double the size of the company.
Ian McDonald
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