Morgan Stanley's 4 Health Care and Pharma Stocks to Buy for the Long Term

NEW YORK (TheStreet) -- Navigating the world of equities can be troublesome when investors have to consider oil prices, currency swings, Fed policy translations, geopolitics and other factors that are put into play. But there are plenty of U.S. companies that could be long-term picks, despite these macro factors.

Morgan Stanley analysts identified "high-quality companies likely to strengthen and extend a sustainable competitive advantage," resulting in a "30 for 2018" list. The analysts put forth their best investment ideas "in their sectors at times of market dislocations or uncertainty." The stocks are considered suitable for holding for a three-year time period, according to the report, issued Thursday.

"Our driving principle was to create a list of companies whose business models and market positions would be increasingly differentiated by 2016," the report said.

"The main criterion is sustainability -- of competitive advantage, business model, pricing power, cost efficiency, and growth. We selected the companies that scored best on these criteria," the report said. The analysts also took into account capital structure, shareholder remuneration, as well as environmental, social and governance principles, which can "shed light on a management team's approach to sustainable and responsible governance over the very long term."

Here are Morgan Stanley's top picks for the health care and pharmaceuticals industries stocks. We paired Morgan Stanley's views with ratings from TheStreet Ratings for comparison.

TheStreet Ratings, TheStreet's proprietary ratings tool, projects a stock's total return potential over a 12-month period including both price appreciation and dividends. Based on 32 major data points, TheStreet Ratings uses a quantitative approach to rating over 4,300 stocks to predict return potential for the next year. The model is both objective, using elements such as volatility of past operating revenues, financial strength and company cash flows, and subjective, including expected equities market returns, future interest rates, implied industry outlook and forecasted company earnings.

Buying an S&P 500 (SPY) stock that TheStreet Ratings rated a "buy" yielded a 16.56% return in 2014, beating the S&P 500 Total Return Index by 304 basis points. Buying a Russell 2000 (IWM) stock that TheStreet Ratings rated a "buy" yielded a 9.5% return in 2014, beating the Russell 2000 index, including dividends reinvested, by 460 basis points last year.

Note: Year-to-date returns are based on May 15, 2015, closing prices.

ACT Chart ACT data by YCharts

1. Actavis (ACT)
Market Cap: $116.5 billion
Year-to-date return: 15.2%
Morgan Stanley Rating/Price Target: Overweight/$343 PT

Morgan Stanley said: We believe Actavis stands at a unique cross-section between both Specialty and Major Pharmaceuticals. Since August 2013, Actavis has transformed itself from a small, $18 billion market cap generics company into an over-$120 billion market cap branded pharma powerhouse. Actavis recently closed its acquisition of Allergan, which should step up branded pharma earnings from ~56% of 2016 EPS pre-deal to ~77% post-deal. We believe Allergan has several interesting pipeline candidates -- DARPin (wet age-related macular degeneration), Botox (in new medical indications such as depression and osteoarthritis pain), and bimatoprost sustained release (glaucoma). Allergan also plans to refile Semprana (levadex; migraine). Hence, our 2020 Allergan pipeline projection of $1.4 billion could prove conservative.

TheStreet Ratings: Buy, B-
TheStreet Ratings said:
"We rate ACTAVIS PLC (ACT) a BUY. This is driven by some important positives, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its robust revenue growth, solid stock price performance, good cash flow from operations, expanding profit margins and largely solid financial position with reasonable debt levels by most measures. We feel its strengths outweigh the fact that the company has had sub par growth in net income."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • ACT's very impressive revenue growth greatly exceeded the industry average of 7.8%. Since the same quarter one year prior, revenues leaped by 59.5%. This growth in revenue does not appear to have trickled down to the company's bottom line, displayed by a decline in earnings per share.
  • Compared to its closing price of one year ago, ACT's share price has jumped by 53.80%, exceeding the performance of the broader market during that same time frame. Regarding the stock's future course, although almost any stock can fall in a broad market decline, ACT should continue to move higher despite the fact that it has already enjoyed a very nice gain in the past year.
  • Net operating cash flow has increased to $525.00 million or 30.37% when compared to the same quarter last year. In addition, ACTAVIS PLC has also vastly surpassed the industry average cash flow growth rate of -23.44%.
  • The gross profit margin for ACTAVIS PLC is rather high; currently it is at 68.80%. It has increased significantly from the same period last year. Regardless of the strong results of the gross profit margin, the net profit margin of -12.09% is in-line with the industry average.
  • The debt-to-equity ratio is somewhat low, currently at 0.62, and is less than that of the industry average, implying that there has been a relatively successful effort in the management of debt levels. Although the company had a strong debt-to-equity ratio, its quick ratio of 0.80 is somewhat weak and could be cause for future problems.
HCA Chart HCA data by YCharts

2. HCA Holdings (HCA)
Market Cap: $33 billion
Year-to-date return: 8.8%
Morgan Stanley Rating/Price Target: Overweight/$96 PT

Morgan Stanley said: We believe HCA is differentiated from other large-cap Health Care Services companies due to its scale, diversification and urban market positioning of its portfolio. In contrast to its peers, HCA benefits from its exposure to more vibrant local economies, which allow for a more focused approach to creating value in existing markets. In addition, HCA has positioned itself well to capitalize on longer-term structural shifts in health care delivery that are expected to drive greater integration and alignment of incentives between health systems and payors.

Specifically, HCA will continue to direct capital to expand access points, broaden its service offerings, and establish greater depth in existing service lines to capture higher-intensity or more complex cases. Not only should these investments yield higher margins, but they should allow the company to capture share and keep patients within the HCA system. As such, HCA's disciplined approach to investment is expected to continue to yield mid- to high-teens return on invested capital and support its long term organic EBITDA growth of 3-5% -- even before incorporating benefits from reform and capital deployment.

Simply, we believe HCA is best positioned to capitalize on positive secular trends in the industry including health care reform, the aging of the U.S. population, and increased government spending on health care programs over the next few years.

TheStreet Ratings: Buy, B-
TheStreet Ratings said:
"We rate HCA HOLDINGS INC (HCA) a BUY. This is driven by a number of strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its solid stock price performance, impressive record of earnings per share growth, compelling growth in net income, revenue growth and good cash flow from operations. We feel its strengths outweigh the fact that the company shows low profit margins."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • Powered by its strong earnings growth of 78.94% and other important driving factors, this stock has surged by 48.60% over the past year, outperforming the rise in the S&P 500 Index during the same period. Regarding the stock's future course, although almost any stock can fall in a broad market decline, HCA should continue to move higher despite the fact that it has already enjoyed a very nice gain in the past year.
  • HCA HOLDINGS INC reported significant earnings per share improvement in the most recent quarter compared to the same quarter a year ago. The company has demonstrated a pattern of positive earnings per share growth over the past two years. We feel that this trend should continue. During the past fiscal year, HCA HOLDINGS INC increased its bottom line by earning $4.18 versus $3.36 in the prior year. This year, the market expects an improvement in earnings ($5.20 versus $4.18).
  • The net income growth from the same quarter one year ago has significantly exceeded that of the S&P 500 and the Health Care Providers & Services industry. The net income increased by 70.3% when compared to the same quarter one year prior, rising from $347.00 million to $591.00 million.
  • Despite its growing revenue, the company underperformed as compared with the industry average of 18.5%. Since the same quarter one year prior, revenues slightly increased by 9.6%. Growth in the company's revenue appears to have helped boost the earnings per share.
  • Net operating cash flow has significantly increased by 129.79% to $1,018.00 million when compared to the same quarter last year. In addition, HCA HOLDINGS INC has also vastly surpassed the industry average cash flow growth rate of 68.02%.

 

MCK Chart MCK data by YCharts

3. McKesson (MCK)
Market Cap: $56 billion
Year-to-date return: 15.6%
Morgan Stanley Rating/Price Target: Overweight/$242 PT

Morgan Stanley said: McKesson is well positioned to nearly double earnings over the next three years, in our view, as it continues to build scale in the U.S. and global pharmaceutical distribution market while benefiting from the high-growth specialty market.

McKesson is the largest pharmaceutical distributor in the U.S. market, accounting for an estimated ~38% market share. Over the next three years, we think McKesson will continue to grow its share in generics -- the most profitable class of drugs for distributors in the U.S. market -- through expansion of current customer contracts, notably Wal-Mart (WMT) and Target (TGT), as traditional retailers look to distributors with larger scale to get better pricing and manage new regulatory burdens. We think these opportunities could add an additional 3-5% to McKesson's generics share and be ~20 cents (~2%) accretive to EPS.

TheStreet Ratings: Buy, A+
TheStreet Ratings said:
"We rate MCKESSON CORP (MCK) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its robust revenue growth, notable return on equity and solid stock price performance. We feel its strengths outweigh the fact that the company has had sub par growth in net income."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • MCK's revenue growth has slightly outpaced the industry average of 13.3%. Since the same quarter one year prior, revenues rose by 18.7%. This growth in revenue does not appear to have trickled down to the company's bottom line, displayed by a decline in earnings per share.
  • Current return on equity exceeded its ROE from the same quarter one year prior. This is a clear sign of strength within the company. Compared to other companies in the Health Care Providers & Services industry and the overall market, MCKESSON CORP's return on equity exceeds that of both the industry average and the S&P 500.
  • MCKESSON CORP' earnings per share from the most recent quarter came in slightly below the year earlier quarter. This company has reported somewhat volatile earnings recently. But, we feel it is poised for EPS growth in the coming year. During the past fiscal year, MCKESSON CORP increased its bottom line by earning $7.53 versus $6.08 in the prior year. This year, the market expects an improvement in earnings ($12.60 versus $7.53).
  • Compared to its closing price of one year ago, MCK's share price has jumped by 31.75%, exceeding the performance of the broader market during that same time frame. We feel that the stock's sharp appreciation over the last year has driven it to a price level which is now somewhat expensive compared to the rest of its industry. The other strengths this company shows, however, justify the higher price levels.
  • The gross profit margin for MCKESSON CORP is currently extremely low, coming in at 6.49%. It has decreased from the same quarter the previous year. Along with this, the net profit margin of 0.29% trails that of the industry average.

 

 

MDT Chart MDT data by YCharts

4. Medtronic (MDT)
Market Cap: $109 billion
Year-to-date return: 5.8%
Morgan Stanley Rating/Price Target: Overweight/$83 PT

Morgan Stanley said: Our thesis on Medtronic is predicated on three elements -- faster growth, higher returns to shareholders and greater consistency of results. In our view, Medtronic's unmatched product breadth and business scale create a competitive advantage as Med Tech customers drive toward bundling. The transformational acquisition of Covidien has laid the foundation for execution on all three items. Multiple senior management changes have occurred, and we believe these may not be widely understood by the Street.

Recent results demonstrate improving execution and multi-quarter growth consistency, which we expect to be rewarded with multiple expansion. We believe the Street does not fully appreciate the change in this dynamic or the impact of multiple senior management changes that could foster a growing culture of execution in the coming years. While structural growth rates languished in the low single digits over F2011-14, improving markets and better recent pipeline product has driven growth into the mid-single-digits, and we see potential upside going forward.

TheStreet Ratings: Buy, A
TheStreet Ratings said:
"We rate MEDTRONIC PLC (MDT) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its revenue growth, reasonable valuation levels, solid stock price performance, good cash flow from operations and growth in earnings per share. We feel its strengths outweigh the fact that the company has had generally high debt management risk by most measures that we evaluated."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • MDT's revenue growth has slightly outpaced the industry average of 1.1%. Since the same quarter one year prior, revenues slightly increased by 3.7%. Growth in the company's revenue appears to have helped boost the earnings per share.
  • Powered by its strong earnings growth of 30.66% and other important driving factors, this stock has surged by 25.75% over the past year, outperforming the rise in the S&P 500 Index during the same period. Regarding the stock's future course, although almost any stock can fall in a broad market decline, MDT should continue to move higher despite the fact that it has already enjoyed a very nice gain in the past year.
  • Net operating cash flow has slightly increased to $1,767.00 million or 9.61% when compared to the same quarter last year. The firm also exceeded the industry average cash flow growth rate of -17.49%.
  • MEDTRONIC PLC has improved earnings per share by 30.7% in the most recent quarter compared to the same quarter a year ago. This company has reported somewhat volatile earnings recently. But, we feel it is poised for EPS growth in the coming year. During the past fiscal year, MEDTRONIC PLC reported lower earnings of $3.01 versus $3.38 in the prior year. This year, the market expects an improvement in earnings ($4.39 versus $3.01).

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