10 Questions With Dresdner RCM Global Health Care Fund Skipper Faraz Naqvi
Faraz Naqvi's diagnosis of sleepy, steady HMO stocks is bleak but he thinks biotech shares are ready to leave the sick bay in a big way.
In surveying his sector, Naqvi, an MD who manages the
(DGHCX)
Dresdner RCM Global Health Care and
(DRBNX)
Biotechnology funds, is uncharacteristically blunt compared to most sector-fund managers, who tend to be perennially bullish on their industries. He thinks HMOs will buckle under fat stock valuations and increased pricing pressure, while the spectre of fixed drug prices will weigh on pharmaceutical stocks. At the same time, he thinks next year will be a blowout for mercurial biotech stocks as new drugs and alliances with big-pharma shops underscore the subsector's stability.
Manager:Faraz Naqvi, M.D. |
Fund: Dresdner RCM Global Health Care |
Managed Since: |
1-Year Return: 10.6%/Beats 65% of peers |
Expenses: No-Load/1.50% annual expense ratio |
Top-Three Holdings: |
Source: Morningstar |
There's reason to listen to Naqvi. Since he took the reins in 1999, the Global Health Care fund topped the category's average 55% gain last year and its 9.4% dip this year isn't bad compared to the category's nearly 12% average loss. And the Biotechnology fund's 56.2% average annual gain over the past three years tops all its peers.
Long story short, if you're looking for a pharma juggernaut, look at
Pfizer
(PFE) - Get Report
. And if you're shopping for
the
biotech bellwether, check out
Genentech
(DNA)
. But he sees plenty of other gems and poison pills, so read on.
1. Where do you see health care stocks going in the rest of this year?
Naqvi:
One of the interesting things about the health care sector is we have differential performance. There are certain subsectors that do really well at times, and usually those aren't associated with other subsectors. Pharmaceutical stocks are considered defensive, but biotech, on the other hand, is very aggressive. When people are very optimistic in market cycles and buying
Nasdaq
-type stocks, biotech stocks go up even more than tech stocks. The ultimate defensive sector is probably the hospitals and HMOs.
I think the pharmaceutical stocks are going to be very affected by the political environment, which I think is going to be fairly bad for them. There's something called the
Medicare
drug benefit that has a direct impact on the next three years' worth of earnings of the pharmaceutical stocks.
Is that because it affects drug prices?
Naqvi:
Yes, it's fixing drug prices for all people over 65, which could have a really negative impact, unless it were passed right now.
President
George Bush
is supporting this proposal by Sen. John Breaux (D.-La.) and Bill Frist (R.-Tenn.). It would actually fix prices among the Medicare drug recipients. However, it's probably the best of all worlds for the pharmaceutical companies. If that passed, it would sort of clear the air, remove the overhang on the pharmaceutical industry. The chances of that happening are pretty slight until the end of the year. So I think that overhang is going to hold down valuations of the pharmaceutical stocks for the rest of the year.
Pretty Healthy Overall |
|
Source: Morningstar. Returns through June 14. |
Biotech, I think, is going to do great. We predicted that we'd go through what's called the summer doldrums, where there's not a lot of news events to feed biotech and a lot of people are taking profits. You run into a period when things really aren't moving and people are just selling. That's what we're hitting right now in biotech, but I think that in the second half of the year it's going to do great.
What's making you so bullish on biotech?
Naqvi:
There are a lot of news events coming up. There are a couple of big product approvals:
Amgen
(AMGN) - Get Report
has a drug called
NESP
, which is more of a big indicator for biotech. When Amgen or
Genentech
(DNA)
has drugs approved, usually that causes the whole sector to move. Genentech is also expecting approval of a drug called Xolaire, for asthma. Those things are more symbolic than anything else. The symbolism of actually getting things passed causes a general move in overall valuations.
The health care service stocks -- hospitals and HMOs -- are going to be the most troubled in the second half of the year. We're clearing out of many of those stocks. We're holding on to the hospitals more so. But HMOs are hitting a bad business cycle: Since companies are less willing to retain employees, they're less willing to pay high prices for health care programs, and that's bringing price pressure on the HMOs. Now they're dependent on cost-cutting, which they've never really been good at doing. So that says to me that that's probably a bad sector for the near term.
Also, weren't their valuations pretty high, relative to their historical valuations, coming out of 2000?
Naqvi:
Yeah. They were hitting the all-time peak of their overall valuations, and that was during a really good HMO market environment. So our feeling is, stay away from the HMOs. Still invest in a few of the select hospital companies, but not very many.
That's our overall view. As for next year, I don't know what's going to happen to the pharmaceutical industry yet, but I think biotech is going to have a banner year. It's going to be reminiscent of what we saw technology stocks do a few years ago, where we see just huge valuation increases. Some of those are going to be untenable. Some of those are unjustified. But nevertheless I think we're going to see that next year.
A Solid Streak for Health Nuts |
|
Source: Morningstar. YTD returns through June 8. |
2. I was looking at a chart of the Amex biotech index, and it's feast-or-famine. Between 1993 and 1996, the index went up a cumulative 3%. But then over the past three years, it's just been eye-popping. So some folks would counter what you're saying and wonder if biotech is just due to cool off, that it's due for a dry season here, because these are inherently emerging and speculative -- you might almost say emotional -- mercurial stocks. What's your response?
Naqvi:
I tend to agree that some of these valuations are untenable. But we shouldn't ignore a few changes that have gone on just in the last year to two years. One of those is that biotech has proven it's a real sector. They actually have products on the market. They have products in development that will be products on the market. Pharmaceutical companies are increasingly making deals with biotech companies, indicating it is a valid sector and is a valid form of R&D
research and development. And you're seeing big institutions that were very respected, long-term holders of stocks, that five years ago probably wouldn't have had one biotech stock in their portfolio -- now almost every fund owns biotech.
Even if it's just bellwethers like Amgen or Genentech.
Naqvi:
You're even seeing them go down in market cap. You're even seeing them move into the
MedImmunes
(MEDI)
and the
IDEC Pharmaceuticals
(IDPH)
and the
Immunexes
(IMNX)
. We're seeing a downward creep in terms of ownership. That provides a support base, because you're getting big institutions buying into things as long-term holders, whereas before it was mostly very fast money that was in and out of biotech. The momentum still exists to an extent, because you see the prices fluctuate a lot. But I think you are seeing a support base developing for a lot of the better names.
So when we look at 1993 and 1996, you're saying that this is a very different situation, because there are companies with products and profits and more stability.
Naqvi:
A few things make me think biotech is going to be very big next year. One of those is just the self-fulfilling prophecy theory, in that a lot of fund managers are thinking the same way that I am. If everybody thinks that way, we're all going to be pouring money into the market and driving prices up, whether they deserve to be driven up or not.
A second is that we'll be seeing a lot of products hitting the
FDA
. That's going to vastly expand the number of products reviewed that might be biotech drugs. An example would be a class of drugs called monoclonal antibodies. These are sort of magic-bullet type drugs that go directly to whatever disease, whether it be cancer or an infection or whatever you want to attack. There's currently about five of those on the market, all of which are doing very well. But next year there's going be 30 being reviewed for approval by the FDA. Another thing is the data we're going to be seeing coming out of a lot of biotech companies that indicate they have legitimate drugs is going to be very significant. You're going to see a lot of small companies come out with Phase-II, Phase-III data, which means they're right on the precipice of having a really good drug.
A third reason is the rising number of links with pharmaceutical companies. Pharmaceutical companies are increasingly being judged on their pipeline. They have to have something that will sustain them in terms of new products over the next three to five years. Now, they've actually been doing this for years in collaboration with biotech but they never revealed it. The deals were cut so favorably for the pharmaceuticals that they kept these things hidden. Next year, I think there's going to be pressure on the pharmaceutical companies to prove they have very robust pipelines. We're already seeing Pfizer and
American Home Products
(AHP)
showing Phase-I products, but next year I think they're really going to open their kimono and show all the deals that have been cut with biotech, and I think people are going to get really enthusiastic about the value of biotech. Whether that'll be sustainable over more than next year, I don't know.
It's never going to be a smooth ride, right? Because they trade so actively on news, and, as you said, short-term events.
Naqvi:
Right, it may not be sustainable. In fact, next year I'd be very aggressive about buying things in the beginning of the year, and I'd be very aggressive about selling them once they reached these absurd valuations. That's the way I feel that we'll make a lot of money next year.
3. Looking at pharmaceutical stocks takes a lot of research, because future earnings are simply the annuitized revenue from what's in the pipeline now. So determining who's going to be making the most money down the road really requires looking very closely at the drugs in those pipelines. That's hard for an individual investor to do. Among the big-pharma shops, who has the combination of the best pipeline and the best marketing organization?
10 Questions Archive |
Berger Information Technology's Bill Schaaf |
Hancock Focused Relative Value's Tim Quinlisk |
Gabelli Growth's Howard Ward |
Flag Investors Communications' Bruce Behrens and Liam Burke |
Dreyfus Technology Growth's Mark Herskovitz |
Naqvi:
Easy: Pfizer, without a doubt. They have over 100 products in clinical development right now, and they have the most powerful marketing organization around. Companies like
Merck
(MRK) - Get Report
have an excellent marketing force but have a relatively weak pipeline. Companies like
Eli Lilly
(LLY) - Get Report
have a great pipeline but a horrible marketing force. The other day I heard a sell-side analyst use a great analogy, that Lilly's marketing force is like a bunch of guys sort of straying down the highway, not knowing which way it's going. And then there's this big blue truck with the word 'Pfizer' on it just running them over. And that's the way Pfizer is. They're just big and huge and they just overwhelm people.
4. In the biotech area, who jumps out at you as being a consistently well-run business on the science side and on the finance side?
Naqvi:
Genentech. My prediction is that you'll see Genentech emerge as the premier biotech. Right now Amgen is considered that because a couple of their drugs sell incredibly well. But if you look at Genentech, their marketing force is outstanding. What they did with IDEC Pharmaceuticals and their drug Rituxan was amazing. They basically took an area, lymphoma, which is a form of blood cancer, and transformed it to their drug being the standard of care. It's just that they have not been blessed with that blockbuster potential drug as Amgen has. If you look at the number of shots on goal they have, shots at making a big impact, Genentech has a lot. So it's my belief that you'll see them emerge as the premier biotech company.
5. Do any companies jump out at you as being good combinations, companies that might be good fits for each other? Or are we sort of beyond that right now?
Naqvi:
Yeah. The whole speculation about
Schering-Plough
(SGP)
and Merck makes a lot of sense. According to our calculations, Merck could actually pay close to $60 a share for Schering-Plough tomorrow and never have to wring one cent in synergies to make it accretive. All they'd have to do is go change the name on the door from Schering-Plough to Merck.
Do you think it's going to happen?
Naqvi:
I think it is. It's just a matter of time. I think what's happening is that to save face a little, the management at Schering-Plough is trying to resolve some manufacturing issues. Another combination that I think will happen sometime is Pfizer and
Phamacia
(PHA)
. Pfizer essentially bought
Warner Lambert
for one drug. I think they're going to buy Pharmacia for something called the Cox-II inhibitor class of drugs. I think you'll see them buy the company just for access to that franchise of drugs.
Other ones that seem to make sense ...
Novartis
, a Swiss company, is really looking around to try to merge with somebody. They and
Bristol-Myers Squibb
(BMY) - Get Report
actually make a lot of sense, but right now the speculation is either between American Home or Bristol-Myers, both of which would be fine for Novartis. Novartis has a pretty good pipeline, but they need that core franchise of products and a really good American sales force, which both American Home and Bristol-Myers have. So I'd speculate that Novartis is probably going to merge with one of those companies. Probably American Home.
For more on Naqvi's thoughts on the health care sector and the three stocks he would buy and hold for the next five years, read the second half of today's 10 Questions.
Fund Junkie runs every Monday and Wednesday, as well as occasional dispatches. Ian McDonald writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
ian.mcdonald@thestreet.com, but he cannot give specific financial advice.