Your Health is your Wealth
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Your Health is your Wealth
Between 2019 and 2050, the percentage of the world population that will be aged over 65 is set to increase by 48%, as mortality rates continue to rise with significant advances in modern medicine and healthcare. Western nations are also becoming increasingly health-conscious, in terms of lifestyle and diet. Furthermore, Technology means our ability to access healthcare, and the quality of such care, has improved immensely. This improvement is set to continue in the coming years, as technology and healthcare systems innovate and break new ground in both treatments and preventative medicines. The development of the first mRNA vaccine last year to fight COVID-19 is one example of the huge innovation within the healthcare sector. Advancements in precise detection and diagnoses of disease will also help in reducing the cost of treating illnesses.
Global life expectancies are rising, Source: UN
In conjunction with this, the increase in globalisation (and dependence on it – recent gas shortages case in point) over the last 20 years has meant that the potential for the rapid spread of disease is much higher than it has hitherto been. Look no further than COVID-19 for evidence of this. As well as this, chronic diseases (e.g. cancer and heart disease) are a huge issue, with 7/10 people dying from such diseases each year. This provides a huge market for companies able to develop treatments and cures for such conditions.
Alongside an aging population, western nations are having fewer children. Europe and North America’s populations are predicted to increase by 2% between now and 2050, compared to sub-Saharan Africa’s predicted 99% growth (one reason The Spark holds Airtel Africa). Such demographics for western nations could create a deflationary environment and lower GDP growth, as more people retire and live longer this trend will reduce the workforce size and therefore lower productivity. An aging population also means increased spending on health and social care.
Companies have clearly recognised the opportunity in the space. Alphabet (Google’s Parent company) has just launched its own Artificial Intelligence (AI) company, Isomorphic Labs, which aims to discover new drugs. Since AI teaches itself, this will rapidly speed up such discovery, and hopefully cure some of the world’s most devastating diseases.
What is the price of your health?
As an investment, healthcare is usually classed as more defensive in nature. People have, and always will, need healthcare. No matter the stage of the business/economic cycle, whether in a deep recession or a booming expansion, everyone will continue to buy the medical products they need. Would you choose money over health? With that said, depending on the niche you invest in, there may be rapid vs low growth, or stable vs sporadic income. For example, the use of AI in both medical and surgical interventions is a new concept, and I am sure it will be part of the next generation of medical research. However, an early-stage medical AI company may have little income, or only one product. Therefore, its income streams are concentrated and more volatile. This could mean higher growth, but such stocks often perform in line with technology companies rather than defensives. On the other hand, for a well-established medical conglomerate which resells unpatented products or prescription medications, its stock would be a lot less volatile and may pay dividends. Such companies are a lower risk investment owing to more stable income streams.
Share price volatility differs between niches in the healthcare sector, GlaxoSmithKline (GSK) vs Protagonist Therapeutics (PTGX), Source: Bloomberg
However, no matter the sector you buy into, there is clearly a huge scope for growth across all areas of healthcare. The problem comes when trying to find the companies with the right credentials to achieve such growth. How could you have identified which company would be the first to produce the COVID-19 vaccine last year?
For healthcare companies, cash is king. The capital expenditure for new projects is huge. Companies burn through billions of dollars trying to find a particular medication that works, before completing the relevant trials in order for it to be approved for wider usage. This is a long, slow process, and there is no guarantee that any medication will be accepted by the relevant governing body, even after passing all trial stages. This means they need huge cash piles to fund new projects and remain solvent.
Weathering the storm with GARP
The Spark will continue to seek growth at a reasonable price (GARP) through companies that produce sufficient cash to weather the storm as liquidity is drawn from the market. When you purchase a stock, you are paying for the future cash flows of that business, so the price you pay is paramount in successful investing. As Benjamin Graham once said, ‘Price is what you pay, value is what you get’. This is why I am adamant about valuations and cash flow conversion for the majority of companies that I hold within The Sparks portfolio. Growing margins is also a major factor to consider, especially during the inflationary spiral we currently face, as this conveys that the business can raise prices to absorb rising costs.
I plan to give a thorough macroeconomic update in next week’s article, but looking around global markets today, there is a lot of uncertainty as liquidity is being drawn from the market. There was a relief rally in stocks toward the end of this week as the Federal Reserve’s Chair Jerome Powell assured markets interest rates would not rise until the job market has improved further. Prior to the Federal Open Market Committee (FOMC) announcement, markets had priced in two rate hikes during 2022. They have now priced in one, in September of 2022, hence the current rally in stocks. Also, the Bank of England’s decision not to raise rates created heightened volatility, especially in the bond market. Although ultra-easy monetary policy is still in place, I am happy to remain conservative over the coming months if that means protecting capital when turbulence arrives.
I hope I conveyed in my article on Airtel Africa (AAF) the importance of extensive research before making any investment (and the amount that could be written on individual companies) – as well as the benefits of such research (AAF up 10% this week). I will try to keep each recommendation clear and concise, so these weekly updates are kept to a reasonable length, however I can assure you that the same depth of research was completed.
For broad exposure to the healthcare industry, there are many low-cost ETFs which could be purchased such as iShares Biotech ETF (BTEK) or VanECK biotech ETF (BBH). These invest in between 25 and 50 stocks so are less volatile than individual companies. Also, there are excellent investment trusts which are actively managed (therefore higher cost) such as Worldwide Healthcare Trust (WWH) and The Biotechnology Growth Trust (BIOG). Looking at individual names, you could purchase companies supplying equipment to medical practices such as Judges Scientific (JDG), those at the forefront of surgical innovation such as Intuitive Surgical (ISRG), or those recreating generic medication such as Hikma Pharmaceutical (HIK). If you are seeking an individual name, it is paramount you understand the niche they operate in, as each is very different and carries its own risks.
This week I will add three healthcare stocks to The Spark’s portfolio. For healthcare companies, and in particular the biotechnology industry, there is heightened risk of failed trials or poor results. I have decided to take larger positions in diversified businesses and a smaller position in a higher-growth biotechnology company in the hope of generating additional alpha.
Regeneron’s Next Twelve Month (NTM) EV/EBITDA, Source: Bloomberg
The first diversified business I will add to the portfolio is Regeneron Pharmaceuticals (REGN). It has expertise in oncology (cancer treatment), among many other niches such as its Asthma drug, Dupixent. Dupixent has seen 55% growth in the past nine months and only serves 270,000 out of a potential 4mn eligible patients in the USA. Sentiment has been in the gutter for Regeneron as several drug patents are due to expire by 2023. However, these are only patents for part of each medication, with many of the patents still intact until 2030. This has caused the stock to trade at its lowest valuation since it turned a profit in 2013 (see above). Management has become increasingly frustrated by this lack of respect by the market, and its recent results have conveyed the efficient operation REGN is running. The company created an anti-viral cocktail to treat COVID-19 (REGEN-COV), which delivered $4.7bn of revenue this year, causing its results to surprise the market by 50% to the upside. Putting this in context, Tesla’s shares rallied by 40% on news that Hertz would purchase 100,000 cars, before Musk tweeted that a deal had not yet been signed. The shares are still up 40%. Since surprising 50% to the upside with revenue, Regeneron’s shares rallied before pulling back almost 6%. The company’s net income is up 94% this quarter compared to 2020, and REGN has $5.7bn in cash on the balance sheet. This provides an excellent opportunity for research and development or acquisitions in the future, which I believe the market isn’t pricing in.
Another well diversified large-cap healthcare stock I am adding to the portfolio is Bristol-Myers Squibb (BMY). This company has recently entered a takeover of Aurinia Pharmaceuticals (AUPH) alongside Pfizer (a company I was close to adding to the portfolio). There are rumours that they plan to spin AUPH into a new entity, but whether they do or not, AUPH gives Bristol-Myers exposure to autoimmune disease treatments they didn’t previously have. BMY has a free cash flow yield of 11% and its margins have been booming in recent years. Its EBITDA margin rose from 29% in 2016 to an expected 50% for 2022, with net income margins rising from 25% to 36% in the same timeframe. This comes alongside a 147% increase in revenue. The company has a net cash position and is using this to fund acquisitions. They acquired the drug called Myokardia (currently in phase three trials), which treats cardiovascular diseases, as well as the company Forbius, which specialises in Cancer and Fibrotic diseases. This monumental growth comes alongside a ridiculously cheap valuation once again (see below). The company hasn’t been valued this cheaply since 2009, and with the growth this company has shown at the current valuations means the odds of share price appreciation are stacked in my favour.
BMY NTM EV/EBITDA, Source: Bloomberg
The final company being added is Vertex Pharmaceuticals (VRTX). This company is a higher-risk investment due to its dependence on a Cystic Fibrosis drug, TRIKAFTA, which accounts for the majority of its revenue. The company is trading extremely cheaply due to its revenue concentration, as well as potential competition from AbbVie, who plans to announce a Cystic Fibrosis programme in the coming weeks. However, VRTX beat earnings expectations for 2021 Q3 by 15% and revenue is up 6% to $1.98bn. The company has operating margins of 60% and net income margins have risen from 12% to 43% from 2016 into 2022 (expected). VRTX also has $6bn in cash which can be used to fund acquisitions in order to diversify revenue. Due to the bearish arguments above, the stock has sold off and now traded at its lowest ever valuation, even though it has beat earnings every quarter since 2016, bar one. It is beaten-down stocks like this with great margins and growth that you should look for to generate additional performance within your portfolio, so I feel a small position in Vertex at its current valuation is worth the risk.
VRTX share price, Source: Bloomberg
On a side note, I have recently seen many novice investors state that they hold a stock because **insert Famous investor** holds it. Professional investors have the ability to short as well as go long on a stock. Shorting means that rather than betting on the price of an asset rising (going long), the investor is betting on the price of the asset falling. This is an extremely dangerous strategy, as unlike going long where there is only a 100% maximum loss if the asset goes to 0, if you short an asset, it can theoretically go to infinity (stocks can rise to any price). My point is this – a professional investor does not have to declare he/she is shorting a stock, so if you see them holding a long position in said company, they may be using this as a hedge for a large short position as they are betting on the stock price going down.
I hope this week’s article (and the special edition relating to the FOMC event) help your understanding and analysis of market internals. Please leave any feedback you have in the form on the ‘Newsletter’ page and don’t forget to subscribe to the mailing list to receive every article direct to your inbox!
Until next time,
Peter.
Disclaimer
This communication is for informational and educational purposes only and should not be taken nor used as investment advice, as a personal recommendation, or solicitation to buy or sell any financial instrument. This material has been prepared without considering any particular recipient’s investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or structured product are not, and should not be taken as, a reliable indicator of future performance. I assume no liability as to the accuracy or completeness of the content of this publication.