Health Stock Rally May Live On After Reform

Wednesday, 23 Dec 2009 02:19 PM

 

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This holiday season, some of the best discounts on Wall Street may still be found in the healthcare sector.

Despite a recent rally, healthcare stocks remain cheap and poised to continue their run should the cloud of health reform keep dissipating, analysts and money managers say.

"You still have a good deal of uncertainty related to healthcare," said David Katz, chief investment officer with Matrix Asset Advisors in New York.

"While the stocks have had a pretty meaningful bounce, they're still at depressed valuations and there will be select opportunity."

Investors may seek the sector's allure as a defensive investment with the economy potentially staying rocky in 2010. Biotechnology stocks, as well as those of drugmakers and health insurers, could see gains in the next month.

For his part, Katz likes medical device companies Medtronic Inc and St Jude Medical, biotechnology company Genzyme and drugstore chain Walgreen Co.

Healthcare stocks have outperformed the market this quarter as Congress moved toward passing legislation that appears less ominous than initially feared for the sector.

The U.S. Senate is expected to approve its bill on Thursday. The Senate will then meld its version with one passed by the House of Representatives, and both chambers must approve the bill again before sending it to President Obama.

Despite the advanced phase of the process, many investors may be wary of buying shares before the bill becomes law for concerns of any changes in the last stages.

"This period between now and the time that something is formally signed by the President, assuming all that happens, there is going to be a rally," said Avik Roy, a healthcare analyst with boutique equity research firm Monness Crespi Hardt.

"There's certainly a lot of money that's been on the sidelines from generalists who just didn't want to be involved with healthcare while there was all this uncertainty," Roy said.

Roy points to mid-cap biotech stocks and large pharmaceutical stocks as two groups that could rise at least 10 percent over the next month. The legislation currently leaves both industries relatively unscathed, he said.

Shares of large health insurers — the industry probably most affected by the legislation — have soared about 26 percent since the start of October, leading the charge for health stocks. The S&P Health Care Sector index has risen about 10 percent in that time, while the broader S&P 500 index has climbed 6 percent.

Scott Richter, a portfolio manager with Fifth Third Asset Management, said health insurer shares could continue to rise along with those of large biotechnology companies.

As reform winds down, investors will begin focusing on health company fundamentals, which include strong pricing power, cost-cutting opportunities and the ability to adapt their business models, Richter said.

"If the reconciling process takes more of the teeth out of healthcare reform you'll continue to see these companies move up and be judged on their fundamentals, which are frankly very positive," Richter said.

Another factor is the money waiting on the sidelines. In addition to generalists waiting for the bills to pass, Richter also said hedge funds may be avoiding putting money into healthcare until the new year, after selling positions to lock in 2009 gains from the overall market rise.

Healthcare stocks remain cheap compared with the broader market. Through Tuesday, the S&P health sector index traded at 11.9 times next year's earnings estimates, compared to 14.1 times for the S&P 500.

This year, the S&P 500 has risen about 24 percent compared to an 18 percent increase for the health sector index, although since the start of 2008 — dating back before the financial market collapse of late 2008 — the S&P 500 is down 24 percent, compared to a 11 percent decline for the health stocks.

To be sure, risk remains that the bill could become more negative for various industries as the Senate and House combine their respective bills into one. The House bill, for example, contains the creation of a government-run health plan considered harmful to many industries but which analysts largely believe will not be in the final bill.

Les Funtleyder, a healthcare analyst with Miller Tabak, who has claimed for several months the overhang on health stocks was unjustified, said investors are still mis-pricing the risks, leaving more room for the stocks to rise.

"Obviously, some of the discount has been removed," Funtleyder said. "We think there's more to go."

© 2014 Thomson/Reuters. All rights reserved.

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