Pharmaceuticals Stocks

The health care sector in the S&P 500 has had a great run this year.  It is one of the only two S&P sectors which have produced double-digit returns year to date. In the short run, the impressive performance has been attributed to the fact that more than 90% of healthcare companies have reported better than street estimated financials.

In the long run, the entire sector has been mainly benefited from the increasing coverage from the Affordable Care Act (ACA) and generally aging population with longevity, which create a growing and sustainable demand for medical care.  It is estimated that the ACA alone should add an extra $1.8 trillion in healthcare spending by 2025. By 2020, more than a billion people will be over the age of 60.  The ACA coverage expansions are likely to lead to between 15 million and 26 million additional primary care visits annually.  The government predicts that between 4,300 and 7,200 additional primary care physicians will be needed each year to meet new demands.

After the passing of the ACA, and in anticipating the favorable outlook, the health sector has returned over 27% for the last 3 years, and a whopping 130% for the last five years.  Within the sector, the health care facilities and services industries, i.e., hospitals such as Universal Health Services (UHS), have benefited most because they are less exposed to uninsured patients.  Investors interested in these segments of the sector may want to look at ETFs like SPDR Health Care Services (XHS), up 13% since February, and US Healthcare Providers (IHF) up 15%.

That being said, soaring hospital costs have led many health care insurers to drop out the ACA in many states.  Last week, Aetna announced that it will exit the exchanges in 11 states, leaving the nation’s third largest insurance company with only 4 states under the coverage of Obamacare.  The biggest winners for the last few years due to the ACA have been most negatively affected by the announcement.

Long-term investors should consider the health care sector a recession hedge against recessions.  Along with consumer staples, utilities, and other defensive sectors, the health sector stocks continue to be the shining stars even after the break of the most surprising event, Brexit.   In particular, within the sector, the Biotechnology and Pharmaceuticals industries are the least immune to the economic uncertainty.

The ETFs, Arca Biotech ETF (FBT) have been up by 22% since February,Vectors Biotech ETF (BBH) by 20%, Dynamic Pharmaceuticals ETF (PJP) by +14%, and US Pharmaceuticals ETF (IHE) by +15%.

In the space of pharmaceuticals stocks, we like the following particularly for different reasons

I.  Takeover Targets

The most exciting news lately is that Pfizer announced that it would purchase Medivation (NASD: MDVN), at a 21% premium, for $14 billion.  The acquisition was to secure Medivation’s No. 1 selling prostate cancer drug, Xtandi.  Potential targets such as Biogen (NASD: BIIB), BioMarin Pharmaceutical (NASD: BMRN), Clovis Oncology (NASD: CLVS), Incyte Corp. (NASD: INCY), Tesaro Inc. (NASD: TSRO), and Vertex Pharmaceuticals (NASD: VRTX) all rallied on the news.

Unlike most acquisitions, drug companies buy others, not for their low valuations, but for their drugs in advanced testing phases.  Since all drugs need to be approved by the FDA through multiple phases of multi-year testing process, there is little unknown for large public drug companies with respect to the types or the numbers of drugs in the pipelines.  For that reasons, we like the following two potential targets of takeover:

ACADIA Pharmaceuticals (NASD: ACAD): $34.46

ACADIA’s Nuplazid has been approved for Parkinson’s diseases psychosis in April 2016.  It is also cur in Phase 2 of testing for Alzheimer’s and schizophrenia.  It is expected to bring $1 billion revenue before it goes over the counter.  With a negative earnings and -1% YTD return, a perfect profile for a takeover target, it is rumored that Biogen is eyeing them.

Portola Pharmaceuticals (NASD: PTLA): $20.06

Portola’s AndexXa, a “reverse” anti-coagulant to stop bleeding for people on blood thinners, is still in Phase 3 testing.   Over 100,000 patients in the US need this drug. It is the only one of its kind.  Pfizer’s Eliquis, an anti-coagulant, would work hand-in-hand with AndexXa.  With the fact PTLA has lost a whopping 60% YTD, it is widely believed to be Pfizer’s next target.

II. Ultra-Rare Diseases “Orphan” Stocks

We like the following orphan stocks because the companies have the exclusive power to charge the insurers exuberantly high prices.   Still, you may have noticed the short-term event risk.  The Democratic presidential candidate has put the “control on sky-rocketed drug cost” on her campaign platform.  Major drug stocks have been under the pressure for a while.

Alexion Pharmaceuticals (NYSE: ALXN): $137

Alexion focuses on the development and commercialization of therapeutic products, such as Soliris, for “ultra-rare diseases,” which current treatments are either non-existent or inadequate. By targeting ultra-rare diseases with no other treatments, Alexion has been able to place itself into a market with virtually no competition.  Soliris costs Medicare $400,000, per patient, per year, for life.

Ultragenyx Pharmaceuticals (NASD: RARE): $70 

Ultragenyx’s KRN23 (in Phase 3), the only one of its kind, treats degenerative diseases for children. Their rhGUS is for “urinary GAG excretion.”  Both are for ultra-rare debilitating genetic diseases and both are estimated to cost $400,000 a year for treatment.

The Second Sight Medical Products Inc. (NASD: EYES) makes implantable prosthetic devices to restore vision to blind patients.  As their pricy products are paid for by Medicare, EYES is one of the “temporary” victims from the recent presidential rhetoric. However, if you believe their business model, to make products for people who are completely blind, the stock, currently $4.00 from a 52-week high of $15, seems to be a good buy.