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A divided diagnosis for health care stocks

Health care stocks are not holding up as they should in a tough market, says Dow Theory Forecasts, although it finds three sound buys.

In an emergency, health care stocks are supposed to be one of the safer places investors can go.

Like grocery stores and electrical utilities, they fit into that category of investment known as the defensive stock. When all else fails, these stocks will still be bringing in revenue.

A few weeks ago, we looked at health care from a Canadian point of view (see Daily Buy-Sell Adviser, February 18). But of course any investor with a serious interest in health care stocks must also look to the United States, where there is a far greater choice.

And when we do look south of the border, we find a disturbing trend. Health care stocks are looking a bit shabby these days.

There is certainly hope for recovery, says a leading U.S. advisory, Dow Theory Forecasts. And there are three stocks that are solid buys in the meantime. But the general prognosis is not good.

The fact is, some of the conventional ideas about health care in troubled times just aren’t holding up.

The boats are seaworthy

“Health care companies’ profits are supposed to remain fairly steady regardless of the economic situation,” says this advisory. “But hospitals’ capital spending fell in the December quarter, and many consumers are putting off medical care because they cannot afford it.”

This has introduced a good deal of confusion for investors. Not to mention poor results. The S&P 1500 Pharmaceutical Industry Index is down eight per cent so far this year and the S&P 1500 Health Care Index about half that, at four per cent.

The news is not all bad, the advisory says. “The wind may have shifted, but the boats remain seaworthy.”

The numbers may be ugly on the surface, with five of the six industry indexes in health care declining in the past 12 months. But all have done better than the broad S&P 1500 Index (the S&P 1500 covers large, mid and small cap stocks).

Defensive is a relative term, explains the advisory, and compared to the 44 per cent decline in the overall index, most health care stocks were relatively healthy.

The Obama plan

Across the U.S., health care spending accounts for a rather sizeable 16 per cent of Gross Domestic Product, so it is essential to the nation’s economic well-being.

And the importance of health care will grow, thanks to an aging population and other demographic trends. According to one source, it should increase by an average rate of 6.7 per cent through 2017.

But there is one potential source of leakage in the boat — President Obama’s proposed health care plan. It promises to cut insurance costs for consumers and make coverage available for those who cannot afford it.

“The plan calls for limiting the profits of managed-care providers and making it more difficult for drug companies to defend patents.” The final version of this plan may well be more business-friendly than it now looks, the advisory adds, but the risks are real.

Still, many health care firms seem capable of continued growth in the advisory’s opinion. Its numbers project double-digit profit growth this year for two segments of the industry, biotechnology and health care services.

By 2010, the market expects a return to growth all across the health care industry. For now, three stocks stand out.

Schizophrenic treatment

The shares of AstraZeneca (NYSE-AZN), the British pharmaceutical giant, were down just 4 per cent last year. That’s a lot less than the industry as a whole.

The company had a setback with some of its antipsychotic drugs — they pose heart risks. But its schizophrenia treatment, Seroquel, had its patent extended by the U.S. Food and Drug Administration (FDA). Overall, it has more than 30 projects in late clinical trials.

Per-share profit growth is expected to be less than one per cent this year, but consensus estimates have been rising lately. The stock trades at a huge discount to its forward valuation.

This stock is a Buy now, says the advisory, and a Long-Term Buy (best buy over the next 24 months).

Stimulus dollars

Johnson & Johnson (NYSE-JNJ) seems to be a durable stock in just about any kind of market. Its sales grew by 4 per cent last year, as a rise in consumer products and medical devices helped offset a slight loss in drug revenue.

Expectations are lower this year, but J & J can help support its revenues with acquisitions. Most recently, it has picked up Chinese cosmetics maker Dabao and breast-implant maker Mentor.

The drug pipeline looks promising as well with five new compounds awaiting FDA approval and two more about to get in line. HIV drug Intelence is on an accelerated review program. This well known stock is a Focus Buy (best buy over the next 12 months) and a Long-Term Buy.

Laboratory Corp. of America (NYSE-LH) could benefit from the U.S. government’s stimulus dollars well before many other companies. The states are getting $87 billion to help cope with the costs of Medicaid.

Many of the tests ordered by doctors will go straight to LabCorp, which controls 20 per cent of the U.S. market for lab tests. It offers more than 4,400 tests and gets most routine tests back in less than 24 hours. In an industry with high fixed costs and a host of regional companies, LabCorp has the capacity to grow with acquisitions and licensing agreements.

As with most health care companies, this one expects to see growth slow this year, but it maintains a steady revenue stream from a long list of large contracts. It is a Buy and a Long-Term Buy.

In a market that’s on life-support, it stands to reason that not all health care stocks are up to scratch. So take only those stocks that can give you a sound night’s sleep.