Take Advantage of the Fire Sale in Healthcare

by Marc Lichtenfeld, Investment U Senior Analyst
Wednesday, August 17, 2011: Issue #1580

The market’s violent sell-off over the past two weeks took down many good stocks along with the bad ones. Even with the quick bounce, quality companies are still trading at steep discounts to where they were just two weeks ago and are now at very attractive valuations.

This is especially true in the healthcare sector, where names like Gilead Sciences (Nasdaq: GILD), which is down 12 percent, are still below where they were trading prior to the debt crisis decline.

Whether the United States’ debt is rated AAA or AA+ should have no bearing on sales of Gilead’s leading HIV drugs or whether its newest drug, Quad, will receive FDA approval.

The stock trades at just 11.2 times earnings despite expectations of 15-percent annual earnings growth over the next five years.

Other biotech blue chips like Biogen Idec (Nasdaq: BIIB) and Celgene (Nasdaq: CELG) are down over 10 percent since the volatility began, despite no significant changes to the companies’ fundamentals.

The large pharmaceutical companies also took it on the chin, although many are on the road to recovery. Still, they appear attractive considering the rich yields that many of them offer.

Last week, I wrote about Abbott Laboratories (NYSE: ABT), which not only yields 3.9 percent, but also has a 25-plus year history of annually raising its dividend.

It’s true that many blockbuster drugs like Bristol-Myers Squibb’s (NYSE: BMY) blood thinner Plavix and Merck’s (NYSE: MRK) asthma treatment Singulair lose their patents next year, but those issues have been talked about ad nauseum and have been priced into the stocks for a while.

An area that got hit particularly hard is healthcare equipment and device makers, which are still down as much as 15 percent from just two weeks ago.

One of the worst hit is spinal surgery device maker NuVasive (Nasdaq: NUVA), which is still off by about a third from when the market slide began.

NuVasive is expected to grow earnings 18 percent annually over the next five years.

Its competitor, industry giant Medtronic (NYSE: MDT), is still lower by 15 percent from just two weeks ago. Medtronic pays a 3.1-percent dividend yield and is trading at just nine times projected 2011 earnings.

Not surprisingly, many of the smaller speculative names are still down big. For example, Lexicon Pharmaceuticals (Nasdaq: LXRX) recently reported strong Phase II results for its carcinoid syndrome drug last week. But that couldn’t stop the massive selling that gripped nearly every stock. As a result, the stock is 26 percent lower than where you would have bought it before the strong results were announced.

About the only area I wouldn’t touch in healthcare are nursing homes, long-term care facilities and home healthcare companies. Medicare cut reimbursements to home healthcare by five percent this year and is likely to do so again next year.

Nursing homes will see a cut of 11.1 percent, or nearly $4 billion, which should have a significant impact on revenue and earnings. The cuts take place on October 1.

Avoid stocks like Kindred Healthcare (NYSE: KND), which has nearly $1.5 billion in debt and will see earnings and cash flow decline in 2012. It will be very difficult for these companies to return to meaningful growth when an important contributor to their revenue is the U.S. government (via Medicare), which isn’t feeling too generous when it comes to entitlements these days.

Other than companies involved in long-term care, the healthcare sector is trading at bargain prices. Whether you’re looking for growth, income, or speculation, there are quite a few names from which you can choose.

Which are your favorites? Leave your comments below.

Good investing,

Marc Lichtenfeld