Targeting the U.S. healthcare market

NEW YORK Thu Sep 20, 2012 11:43am EDT

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NEW YORK (Reuters) - No matter what the outcome of the U.S. election, healthcare looks to be a focal point in the economy for years to come.

The United States spent 17.9 percent of its gross domestic product on healthcare in 2010 - more than double what other wealthy nations spend on a per-person basis. In one sign of the growing importance of healthcare to the economy, S&P Dow Jones Indices added health insurer UnitedHealthcare to the Dow Jones industrial average, replacing Kraft Foods.

Yet healthcare is an industry in flux, grappling with tremendous pressure to bring costs down as a result of an aging population, the 2010 Affordable Care Act and evidence that the extra spending isn't resulting in longer life expectancies for Americans.

That might make healthcare seem risky for investors, but the race to cut costs is creating profits in parts of the industry. With that in mind, here are ways to play the healthcare sector over the next few years.

TARGET COST-REDUCERS

There's money to be made in cutting the cost of care. Rob Lutts, chief investment officer at Cabot Money Management, a Salem, Massachusetts-based firm with $500 million in assets under management, points to biotechnology companies that could reduce the costs of surgery and cancer treatment.

One of his picks, Intuitive Surgical, designs and builds robots that doctors can use to perform less invasive surgeries. The smaller incisions lead to faster recovery for patients and shorter hospital stays.

The company's da Vinci System is in use in more than 1,450 hospitals worldwide, with the number of machines in hospitals growing by about 25 percent a year. The company trades at a price-to-earnings ratio of 36.2, and is up about 10 percent for the year compared with an approximately 16 percent gain for the broad Standard & Poor's 500 index.

One risk: sales in Europe could remain soft for several quarters. The company sold 13 machines in Europe last quarter, compared with 124 in the United States.

Lutts also points to Myriad Genetics, which creates personalized gene maps that can help doctors identify how likely a patient will be to respond to a drug or the risk of a disease progressing or recurring.

"This is bringing a new form of personalized medicine" that will help cut costs through predictive modeling, Lutts said.

The company's shares were bolstered by a U.S. federal appeals court decision in August that affirmed its right to patent two genes linked to breast and ovarian cancer. The risk of further patent challenges remains, however, which could make growth uneven. The stock is up 31 percent for the year and trades at a multiple of 21.2.

Lutts said the court victory will make it likelier that more insurers will adopt "an aggressive strategy" toward working with companies such as Myriad Genetics because mapping out genetic issues could save money, primarily by identifying treatments that will be more successful than others and eliminating the need for multiple treatments to find what works.

LOOK TO COST MANAGERS

Linda Bannister, an analyst at Edward Jones, likes generic drugmakers and health benefit managers, which both turn a profit by helping to manage or cut costs.

Teva Pharmaceutical Industries, for instance, produces generic drugs in more than 60 countries. While the company missed top-line estimates in its most recent quarter, Bannister said Teva is a long-term play because the growing popularity of health savings accounts (HSAs) is creating an incentive for consumers to be cost-conscious.

"Over time we do expect pricing pressure (on brand-name drugs)," Bannister said.

Teva is up 2.6 percent for the year, and trades at a P/E of 11.3. It offers a yield of 2.4 percent. One overhang for the company, though, could be a push by its new CEO to emphasize the company's branded drugs, analysts said.

Brian Tanquilut, an analyst at Jefferies, recently reiterated his buy position for Express Scripts, a pharmacy benefit management company that works with companies such as WellPoint to cut costs.

Express Scripts will likely benefit from the growth of generics and the increase in the number of patients with insurance, Tanquilut wrote in a recent note to clients.

Express Scripts is up nearly 41 percent for the year and trades at a trailing P/E ratio of 31.3. Matthew Coffina, an analyst at Morningstar, looks positively at the company's estimated forward P/E of 13.9, which will come as a result of "squeezing suppliers" because of its "unmatched bargaining position", he said.

(Editing by Jennifer Merritt, Walden Siew and Dale Hudson)

(David.Randall@thomsonreuters.com; 646-223-6607)

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