Montreal-based Swiss and Canadian firm Sectoral Asset Management, founded in 2000 and with $2.6 billion in public equity assets under management per their latest Q3 filing, is an industry-leading specialist in managing global investment portfolios in the healthcare sector. Their investment process is grounded in fundamentals with a strong emphasis on qualitative (not quantitative) factors such as access to senior management, growing therapeutic area, sound business model and a competitive edge.
They build their portfolio from the bottom up, one stock idea at a time, using a Growth at a Reasonable Price (GARP) approach and pushing each stock idea through a rigorous five-step process whetting process that aims to mitigate the specific or unsystematic risk that is associated with healthcare industry stocks due to the industry's complexity, heterogeneity and rapid pace of development. As part of this process, each opportunity is valued and 1-year and 3-year targets established using (depending on the stage of the company) P/E, DCF, EBITDA, Enterprise Value/Sales and peer group analysis models.
The entire $2.6 billion portfolio is deployed in healthcare stocks, with 80% in biotech and drug stocks, and the remaining 20% in medical equipment and supplies group. The fund is moderately diversified into 64 positions, with a third each in large-cap, mid-cap and small-cap equities. The portfolio turnover is 50% with an average holding period of an average of two years, but generally ranging from one- to three-years for most of their holdings.
Based on its most recent Q3 filing, the following are Sectoral's most bullish picks that are also trading at a discount compared to their peers (see Table):
Merck & Co. (MRK): MRK is a research-driven global pharmaceutical company engaged in developing prescription drugs to treat asthma, osteoporosis, cardiovascular, metabolic and other disorders. It also develops vaccines, biological therapies, animal health, and consumer products. At $93 million, this was Sectoral's largest buy as it added a new position in the company in Q3. Also, in our review earlier of the world's largest fund managers, we found that these mega funds collectively added a net $513 million in MRK stock to their $46.05 billion position in the group.
MRK shares have generally fared poorly since their peak in late-2000 at $96, and while there are still looming concerns over patent expirations, which are expected to continue pressuring the top-line over the next few years, valuation seems to have finally caught up. While the stock has been stuck in a trading range, with current prices at the lower end of that range, earnings have continued to rise in recent years, going up from $2.61 in 2004 to a projected $3.83 in 2012 at an average annual growth rate of 4.9%. The stock however is trading at bottom-range valuation at 10 forward P/E and 2.1 P/B compared to the averages of 11.3 and 4.2 for the big pharmaceuticals group. Besides, MRK also offers an attractive dividend yield of 4.4%, well above the 3.3% average for the group.
Covidien Plc (COV): COV is an Irish developer of medical devices, pharmaceuticals and imaging products, and medical supplies for the clinical and home settings. At $63 million, this was Sectoral's second largest buy as it added a new position in the company in Q3. COV too trades at a discount 11 forward P/E and 2.2 P/B compared to averages of 20.4 and 3.8 for its peers in the medical products group. The stock has been stuck in a trading range since its IPO in 2007, mostly between $35 and $55, while earnings in the meantime have exploded from $2.63 in 2007 to $3.97 in 2011 and then a projected $4.63 in 2013. We believe that the stock is a good relative value to its peers, and an attractive buy at these levels.
The following are some additional healthcare sector companies that Sectoral is bullish about, but that are either incurring losses or if profitable, then they are trading at a premium to the average valuation for the group (see Table):
Ariad Pharmaceuticals Inc. (ARIA): ARIA is engaged in the development of drugs that treat aggressive and advanced-stage cancer by regulating cell signaling with small molecules. It is also developing small-molecule drugs that block signal transduction pathways in cells responsible for osteoporosis, and immune and inflammatory diseases. Sectoral added $21 million in Q3 to its $122 million prior quarter position in the company.
ARIA's lead product Ridaforolimus for the treatment of metastatic soft-tissue or bone sarcomas (in patients who had a favorable response to chemotherapy) currently awaits FDA decision in June next year, and it has two other potential blockbuster oncology drugs in its pipeline, Ponatinib in phase 3 for CML and AP26113 in phase 1 for lung cancer and other tumors. The stock recently, on December 27th, received a boost after Rodman & Renshaw made bullish statements about the potential of its ponatinib treatment and other drugs in its pipeline, and raised the price target from $15 to $18.
Amarin Corp. (AMRN): AMRN is a clinical stage Ireland-based global pharmaceutical group, which develops novel drugs for the treatment of cardiovascular diseases using its proprietary advanced oral and trans-dermal drug delivery technologies. Sectoral added a new $18 million position in the company in Q3. AMRN stock is down by almost 70% from the highs in May last year, as the positive story surrounding its lead candidate AMR 101, a prescription-grade omega-3 fatty acid that aims to treat patients with high triglyceride levels, has continued to unravel.
The following are healthcare sector companies that Sectoral is bearish about (see Table):
Celgene Corp. (CELG): CELG develops therapies to treat cancer and immune-inflammatory related diseases by regulating cells, genes and proteins. At $163 million, this was the largest sell for Sectoral in Q3, as it cut its prior quarter $222 million position to $59 million. CELG shares are currently approaching the highs of the year, as earnings are projected to increase strongly from $2.80 in 2010 to $4.51 in 2012, at a growth rate of 26.9%, driven by strong growth in its oncology product line, including Revlimid, Abraxane and Vidaza. The stock trades at a steep discount 15 forward P/E and 4.9 P/B compared to the 27.1 and 8.1 averages for its peers in the biotech genetics group, and keeping in mind also its projected strong earnings growth, the stock is poised to outperform its peers in the group.
Medtronic Inc. (MDT): MDT develops implantable cardiac rhythm devices, spinal implants and other device-based medical therapies. At $110 million, this is the second largest sell for Sectoral in Q3, as it dumped its entire prior quarter position in the company. MDT is a stable growth company with earnings up every year, including through the 2008/09 recession, and it trades at a discount 10-11 forward P/E and 2.4 P/B compared to averages of 20.4 and 3.8 for its peers in the medical products group. However, part of this discount is warranted as earnings at MDT are projected to increase in the 5%-10% annual range while many companies in the group have expected growth in the 15%-20% or higher range.
Hospira Inc. (HSP): HSP is a specialty pharmaceutical and medication delivery company that develops specialty injectable pharmaceuticals based on generic injectable drugs in multiple dosages and formulations, and their I.V. solutions business includes large intravenous solutions and nutritionals essential in every aspect of hospital area. In addition, HSP also offers medication management products including infusion pumps. Sectoral cut $44 million in Q3 from its $61 million prior quarter position in the company. HSP trades at a discount 12 forward P/E and 1.6 P/B compared to averages of 20.4 and 3.8 for its peers in the medical products group, while earnings are projected to fall from $3.31 in 2010 to $2.53 in 2012.
In addition (see Table), Sectoral also cut its position in Q3 in leading biotech company Amgen Inc. (AMGN), in which it cut $109 million from $257 million prior quarter position; it cut $19 million in leading biotech company Gilead Sciences Inc. (GILD); it cut $50 million in Israeli generic and branded drug developer Teva Pharmaceuticals (TEVA); and it cut $21 million in Vertex Pharmaceuticals (VRTX), that is engaged in the discovery, development, and commercialization of small molecule drugs for the treatment of hepatitis C, inflammatory and autoimmune disorders, pain and cancer.
Note to Table: The companies selected to be included in both the Top Buys and Sells and Top Holdings categories in the Table were picked on both an absolute basis, i.e. the highest dollar amounts of buys and/or sells, as well as those amounts relative to their market-cap. That way, the list is not biased towards the largest companies in the group.
Credit: Historical fundamentals including operating metrics and stock ownership information were derived using SEC filings data, I-Metrix® by Edgar Online®, Zacks Investment Research, Thomson Reuters and Briefing.com. The information and data is believed to be accurate, but no guarantees or representations are made.
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