Utilizing top-down sector estimates for the S&P 500 courtesy of ThomsonReuters, the healthcare sector was expected to grow earnings 7% in calendar 2013 as of January 1, but just in the last three weeks, the healthcare sector earnings growth estimate has been slashed to just 1.7% for this year. I'm wondering if it is just pre-release nervousness or conservatism by analysts that have tempered the numbers or the impact of the Affordable Care Act (i.e. ObamaCare) or something else at work that has resulted in sharp downward revisions to the sector.
Healthcare as a sector is roughly 11% of the S&P 500 by market cap weighting.
Here is a brief look at the 5 healthcare giants we follow studiously, and what the Q4 '12 financial report might look like.
Once again, it may not be what Q4 '12 results show, but what managements say about 2013 revenue and earnings per share (EPS) guidance that drives stock price action.
Johnson & Johnson (JNJ) reports Tuesday morning, January 22nd before the opening bell, and although the stock is overbought technically on the daily chart, the fundamentals have really started to improve, particularly the pharma segment. Here is our full-length review published last week: here. To write anything else, would be redundant. We think JNJ easily gets to $80.
Intuitive Surgical (ISRG) reports Q4 '12 on Tuesday, January 22nd after the market closes. We prefer to buy higher-risk growth stocks like ISRG at very low-risk entry points, and we are not yet there for DaVinci manufacturer and true innovator in the medical device business. Q4 '12 EPS consensus is $4.04 and $584 million for expected year-over-year growth of 8% and 18% respectively. Per one note we found after Q3 '12 earnings, the "medical device tax" will cost ISRG $0.46 per share in 2013. (That does not explain why the Q4 '12 earnings growth rate of 8% is well below the historical 22% - 25%, unless the company is taking an early charge for ObamaCare.) Current consensus for 2013 is looking for 17% revenue growth and 19% EPS growth.
For ISRG, the prostatectomy market is probably pretty well saturated or covered in terms of the DV machine, but the hysterectomy and other gynecological markets are growth areas for the company, as well as traditional invasive surgeries of all types. (On a personal note, as someone who was diagnosed with prostate cancer at a fairly young age, I chose a doc who was trained and had experience with the DV to remove the cancerous tumor. Thank you, ISRG.) We have a very small position in ISRG currently, and would only buy more at a $450 price level, or the point of the uptrend line off the '08 - '09 market low.) Fundamentally the stock is very expensive, but with commensurate growth. Our internal model values ISRG near $625, with most of the Street near $525 - $550. We continue to wait on the stock.
Amgen (AMGN) reports its 4th quarter 2012 after the market closes on Wednesday, January 23rd, so the financial results will be completely obscured by Apple and some other higher-profile earnings reports. Street consensus is expecting $1.44 in EPS on $4.366 billion in revenues for expected year-over-year growth of 19% and 10% respectively. 2013 expectations are relatively subdued at 3% revenue growth and 7% EPS growth for the full year, which is a sharp slowdown from full-year 2012's expected 23% and 3%, respectively. AMGN has blown away (excuse the hyperbole) consensus EPS estimates thanks to the stock buyback the last few years. 23% EPS growth on 3% revenue growth is a share-holder-friendly capital allocation. The dividend is very nice too. With a "free-cash-flow yield" of 8%, and healthy free-cash-flow generation, I would fully expect AMGN to do far better than 7% earnings growth in 2013, absent a product catastrophe. The stock has finally pulled back technically, and we think it gets to $100 eventually, which is a 25% return without the dividend. AMGN was up 34% in calendar 2012 without the dividend. It could perform similarly in 2013. Our internal model values AMGN at $102, and the Street is near the mid $90s, but those values are slowly getting walked up. We will look to buy more at $80 or below. AMGN has a February 13th analyst meeting planned: could be a catalyst for the stock. (Amgn has more room for a larger dividend - see the table at the bottom.)
Pfizer (PFE) is scheduled to report Q4 '12 earnings on January 29th, 2013, before the market opens. Pfizer rose 16% in calendar 2012, excluding the dividend. Q4 '12 Street consensus is looking at $0.44 in EPS on $14.4 billion in revenues for declines of 12% and 16% ,respectively. Lipitor coming off patent in 2012 obviously impacted the results, but Q3 '12 revenues were even lighter than expected given Lipitor. 2013 consensus is expected at $2.29 and $57.65 billion for expected year-over-year growth of 6% on a 1% expected decline of revenues. With the Zoetis (PFE's animal health unit) spin-off scheduled for early 2013, proceeds are expected to go towards share repurchases. Pfizer has an 8% "free-cash-flow yield" and has plenty of cash to put into the dividend and share buyback, but the question remains, how much of this already is modeled into the share price. It seems like Pfizer is another capital allocation story in healthcare, with low expectations for the pipeline. Most of the Street has PFE's intrinsic value in the high $20s. Over $30 and without earnings growth, and we might be a better seller. The stock looks like it is getting fully valued.
Merck (MRK) - MRK is scheduled to report its calendar Q4 '12 before the market opens on February 1, 2013. Q4 '12 analyst consensus is expecting $0.81 on $11.5 billion in revenues for expected year-over-year declines of 16% and 7%, respectively. 2013 Street consensus of $3.80 in EPS and $45.574 billion are looking for declines of 3% and 3%, respectively. MRK rose about 9% in calendar 2012, excluding the dividend. MRK gave up a lot of ground after trading to $48 in mid October, '12.
Merck has a free-cash-flow yield of 7% and like Pfizer, has drugs in the pipeline that are promising, but growth for the emerging drugs is not yet enough to offset the drugs coming off patent. Of the two large-cap pharmas, Merck appears to be at the bigger discount to its fair value of $48 - $50 per share. (A hat tip to Dr. Mark Schoenebaum, the ISI biotech and pharma analyst that has turned us on to his research. Dr. Mark does a great job. High quality firm too. ISI's technician, John Mendelson, was early and right on the pharma group and its technical breakout in late 2011, early 2012.) Our internal model values MRK at $63 per share, while Morningstar has a $48 intrinsic value on the stock, as does Dr. Mark. Splitting the difference gets you to $55.
The traditional large-cap biotech and pharma names have very low growth expectations in terms of forward estimates, low expectations for the drug pipelines, and are starting to rationalize expenses and spin-off obsolete units (note Abbott's split and PFE's Animal Health IPO.) The dividends on PFE, MRK, and AMGN will only grow given the healthy cash-flow and free-cash flow of the companies.
AMGN under $80 and MRK today look like slightly better values than PFE at current prices. ISRG is a waiting game for a richly-valued growth stock.
Technically, the healthcare sector looks very good, but the sharp downward revisions in earnings is one worry. That could be part-and-parcel to the medical device tax. We'll know more after the first quarter.
|PFE||$26.50||11(x)||3.45%||8%||$28 - $30|
|MRK||$43||12(x)||3.50%||7%||$48 - $50|
* Source: internal spreadsheets using earnings and 10-Q, 10-K data.
* "Intrinsic value" estimates are arrived via an internal model as well as using Morningstar's "fair value" estimates for each stock.