U.S. biotechs bring healthy returns
B U Y & S E L L ROUNDTA B L E
The strong
loonie has
made U.S.
investments
much cheaper for
Canadian
investors.
Those interested in dipping a toe into U.S. waters will find no better team of advisors than this group. In the second instalment of a four-part roundtable on U.S. investing, our panelists examine the U.S. health-care sector. They tell Buy & Sell columnist Sonita Horvitch that biotechnology giants such as Amgen and Genentech appear to be better bets than pharmaceuticals Merck and Pfizer, which are vulnerable to lawsuits and patent expirations. Q: Why have the mid-caps, represented by the S&P 400, done so well? Chang: A lot of the superior performance of the mid-caps reflects the composition of the S&P 400 index, which has a higher weighting in cyclical stocks at 50% than the cyclical weight of 40% in the big-cap index. The energy names, for example, in the mid-cap index tend to grow their earnings faster than the big caps. Smaller companies in a number of sectors are also benefiting from the use of the Internet and the growth of e-commerce. This has expanded the market for their products. Technology has become less expensive and more powerful, which has helped to increase productivity among smaller companies. We expect U.S. mid-cap companies to continue to outperform the big caps — at least for the next year. The call is for them to grow EPS at 18% in 2006 compared to 6% for the S&P 500 index. Yet, you can buy mid-caps at the same P/E ratio of 16 times 2006 EPS estimates. Q: Peter,what has the MSCI World Index done so far this year? O’ Reilly: In Canadian dollar terms, the MSCI World Index to early September is up a paltry 1.6%. The depreciation of the U.S. dollar has been 7% or 8%, so this index has delivered about 9% in US$ terms. The better performing markets have been Asia ex-Japan and Europe, particularly Germany. Of sectors, we have seen a strong performance from the energy and utilities, and health care has made a recovery. In the European health-care sector, we have seen a strong performance from Novartis, Roche and SanofiAventis. Q: Let’s talk about U. S. healthcare stocks. The sector is still hostage to the U.S. pharmas, which are being held back by concerns about litigation and patent expiry. Hensen: There is also no earnings growth. There are still concerns about the implications of the litigation surrounding
and the drug Vioxx. The fundamentals of the U. S. pharmas are poor. There is no revenue growth and any sign of earnings growth has come from cost-cutting. I do not want to buy perceived growth companies that are in cost-cutting mode. If you look beyond the brand-name pharmas, there are biotechnology companies such as
and
Amgen continues to show strong growth. The HMOs are in an upcycle now. Names such as
are doing well. Medical device and orthopedic implant companies such as
and
are showing great growth profiles. It is hard for the very large pharmas to grow revenues. If you are
you have US$55-billion in revenues and it is hard to grow this. Blackstein: You also have US$18-billion in potential patent expirations between now and 2008. It is better to look at an Amgen or a Genentech, which have substantial patent protection and tremendous growth. You want to buy those that can grow and have the drugs. Right now, it is not the big pharmas. Myszkowski: We are overweight in health care. We have a range of stocks. We own some of the biotech stocks and some of the pharmacy benefit managers. We have holdings in Amgen and In the medical device companies, we have holdings in
and St. Jude. We sold Merck in March of last year, before the Vioxx problems hit. We have cut back on Pfizer. We still have 1.5% of our portfolios in Pfizer. The issue of patent expirations for pharmas are real. It costs billions of dollars to develop these drugs. Blackstein: About 40% of the U.S. portfolio I manage is in health care. But remember I only own 20 stocks. My two biggest positions are Genentech and Amgen. I think Amgen is a stock with good upside over the next few years. Amgen would be my favourite health-care stock. Hensen: We run an all- cap fund relative to the Russell 3000. Amgen is the best-ranked health care company in its market cap category of greater than US$20billion when it comes to positive earnings revisions in our quantitative models. Blackstein: Amgen has been resting on two drugs developed in the eighties and it has done a phenomenal job of milking them. It has a number of drugs in the pipeline for the treatment of cancer and for osteoporosis. These will be announced over the next months probably. The company is trading at 19 times earnings. The analysts consider that this company can grow earnings by 13% or 14%. The potential is much more significant. Myszkowski: You can make the same argument for Gilead Sciences. It has had a number of new products in the HIV and other contagious disease areas. We do not think that the stock is expensive. It is trading at about 24 times next year’s earnings. This is in its mid-range valuation compared to the past several years. Blackstein: Among the largecap pharmas, an interesting company is
It has done a mea culpa, taken a big charge and now the stock has been performing well relative to the other pharmas. It has almost no patent expirations. The big overhang on Pfizer and Merck is the patent expirations. Q: We are not going to see 5,000 again on the Nasdaq Index for quite some time? Blackstein: The stocks that fell apart never come back. It is related to the product cycle. New companies come up with new products and supplant the old ones. Take and They created tremendous wealth and then the P. C. era ends. Microsoft will grow at GDP minus or plus 1% or 2%. Texas Instruments would not exist if it was not for the introduction of new products. Either the company reinvents itself or it disappears. To have ignored the tech sector over the last three years, to have missed
would have deprived you of huge winners. They have been huge winners for us. Who cares if the Nasdaq is going back to 5000? The Internet sector has done well. If you are waiting for companies like to come back, good luck.