Pharmaceuticals: Being Lean While The Markets Are Mean

 |  Includes: DX, IHE, OPK, XPH
by: EricFinance

Pharmaceuticals have traditionally been a safe haven during bearish markets. The Conference Board Consumer Confidence Index has been easing for the past four months and now sits 10% below its February peak. GDP growth is slowing, the presidential elections provide limited visibility, and the European debt debacle seems endless. There really is no shortage of reasons to be anxious. All of this alarm is still not going to stop the aging US population from taking their medications though. So for the next few months at least, it is worth shining the spotlight on this not-so-boring industry.

Indeed, as the chart below portrays, during the first quarter of this year, the market leapt ahead of this refuge sector. But as uncertainty set in, the pharmaceutical and biotech indices held their ground. The overall market peaked on April 2nd, up 12.8% for the year and has now given back a third of those gains, only up 8% YTD. On the other hand, the pharmaceutical ETFs displayed below (XPH and IHE) stagnated along with the market but have reverted back to their traditional strength-during-times-of-weakness selves as the drama in Europe has unfolded by pressing passed those April highs and are now up between 11% and 14% YTD.

Chart 1: YTD Performance of Pharmaceutical Indices and the S&P 500

Click to enlarge

We have shown the two main ETFs that track the industry to prove a point. One may have thought that bigger is better when fear is driving the market. This has not been the case. The weighted average market capital for the holdings in the XPH is $32.9B, while $58.7B for the IHE. The leaner market cap XPH is up 13.7% YTD while the larger market cap IHE is only up 11.2%. Both far outpaced the overall market, but there is a clear investor predilection for the smaller companies during times of panic.

One interesting name in the smaller market capital category that is not in either of these ETFs portfolios is OPKO Health, Inc. (NYSEMKT:OPK). This biotech company has a market capital of $1.3B and is engaged in the development and commercialization of pharmaceutical products, vaccines, diagnostic technologies, and imaging systems. They have been diversifying their arsenal of medications by bolting on smaller companies recently. The mean analyst price target for this stock is $8.25 or a 79% upside potential. The main axe on this name is Jefferies with a buy rating. After recently hosting OPK management at their global healthcare conference, Jefferies was thoroughly impressed. At this conference the company announced an acquisition that added a third-generation hepatitis B vaccine to their product line. Based on company models this acquisition should increase sales by 25% next year.

Nearly 75% of the Jefferies price target is based on the expanding diagnostic (NYSE:DX) programs at OPK. Management has been forthcoming with the investment community about the positive progress on the two main fronts of this effort. The Claros PSA Dx system is expected to be available in the EU by YE12. OPK estimates that 750k of the 1.2mm prostate cancer biopsies performed annually are unnecessary. One of the main benefits of their product is that it should reduce this number dramatically. The company's Alzheimer's Disease (AD) tests are also improving with more optimized tests expected to be completed within a year. The company recently switched from microarray assay to an enzyme-linked immunosorbent assay (ELISA) in order to support higher volume and improve commercial viability. We view this as a positive step for future growth. Kevin DeGeeter, biotech industry analyst at investment firm Ladenburg Thalmann, has been quoted as saying that the AD Dx is a "Potentially transformative event for OPKO's diagnostic franchise."

OPK has also differentiated itself by investing in an emerging market pharmaceutical distribution business which has been the main driver of revenues as other products in the pipeline go through the various stages of approval.

The reassuring aspect of the story is that management is putting their money where their mouth is by increasing their stake in the company in significant ways. Dr. Philip Frost, the CEO and Chairman, has been adding to his stake in the company and now owns 44% of the shares outstanding. Combine that with nearly 24% of its float sold short and you have a perfect set up for strong upside potential. This stock is a good way to generate alpha in the biotech industry which is itself a good play on the bear markets ahead.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.