Despite a weak economic recovery in the US, a recession in Europe, and decelerating growth elsewhere (notably in emerging economies China, India, and Brazil), the S&P 500 has rallied 15% since early June. Low volumes helped encourage the rally.
Equity participation in the rally from both institutional and retail accounts has been lower than normal. US equity mutual funds have experienced outflows of nearly $90 billion this year, while bond inflows have exceeded $200 billion. Underinvested money managers are looking to put money to work ahead of year-end, which for some is October 31st. If funds continue to raise their exposure, the current rally could have further to go. Against this backdrop, we highlight some investment that have lagged their peers or the market this year and where we see specific catalysts which could propel them to catch up in coming months.
Mead Johnson (MJN)
Investment Thesis: The company would benefit from revenue and earnings growth due to acceleration in emerging markets. There is a higher probability of a 4Q rebound in market share in China as competitors ease off on promotional discounts. MJN could be viewed as a cheap call option on a release in the pent-up demand for babies among U.S. families as the economy improves.
Potential Investor Pushback: Investors are concerned that promotional pricing by Western competitors will extend into 2013 and continue to erode industry margins. However, the latest Nielsen data indicates that Danone's pricing is moving higher with, Wyeth (WYE) expected to follow.
Catalysts: Update of its market share in China during the next earnings release on November 1st.
St Jude Medical (STJ)
Investment Thesis: Durata lead will ultimately prove to be a reliable lead. The concerns surrounding the lead are discounting the stock and once the overhang lifts the stock should trade to the mid-40s, possibly in the next 4-6 months.
Potential Investor Pushback: Investors may push back that the stock is not investable until Durata issue dissipates.
Catalysts: The PFO closure data at TCT conference in October could be a catalyst - this could be a new revenue opportunity not in current models. Furthermore, less share loss than people fear due to the Durata lead issue over the next 2 quarters could lift sentiment around the name.
Universal Health Services (UHS)
Investment Thesis: Investors prefer shares of UHS given the company's exposure to the higher growth, higher margin behavioral business. While UHS' acute care business has experienced some difficulties given its concentrated exposure to markets facing difficult economic conditions, the worst may be behind and the acute care segment should benefit from coverage of the uninsured in 2014 through HC Reform.
Catalysts: UHS should complete its acquisition of Ascend Health Corp (the largest private behavioral hospital provider in the U.S.) during 4Q12, which should create meaningful upside to current 2013 EPS estimates. The street may have understated the accretive nature of this deal and we could see upward revisions to EBITDA in the 5-7% range. The stabilization in acute care payor mix, expansion of behavioral bed capacity, and growth in Medicaid rates should allow UHS to take advantage of a relatively easy 2H11 comparison and post better y/y growth with 3Q results.
Potential Investor Pushback: For 1H12, UHS faced a difficult y/y comp given the substantial growth experienced in 1H11, particularly in two important markets, Las Vegas, NV and McAllen, TX. However, the earnings deterioration that UHS experienced in 2H11 creates a much easier y/y comparison. The easy 2H11 comparison plus stabilization within the acute care payor mix should provide some comfort that UHS can post the necessary earnings to meet the y/y growth implied by the company's FY 2012 guidance.
Eli Lilly (LLY)
Investment Thesis: LLY is not a perfect story, and the view on its late stage pipeline is still evolving. However, its outlook materially improved with the Sola release. Pipeline expectations on the stock are very low, and positive news on this front could drive material upside on the stock. Furthermore, its attractive dividend yield (>4%) and long-term guidance on expense management provide downside support to the stock.
Potential Investor Pushback: Sola is the catalyst that is debated the most and has the most risk-reward. While we hope for perfect data on Oct 8th, we think that even good data could lead to a scenario in which at the minimum the FDA accepts the filing for this product. Expectations are still fairly conservative on the Street (peak <$500MM); acceptance of filing by itself could drive positive movement on the stock as estimates rise on the Street.
Catalysts: (1) Solanezumab (Phase 3, Alzheimer's Disease, Oct 8th, 30th): Following encouraging topline press release that saw a partial lift in the stock, the detailed data will be the next step in providing dimension to the commercial potential. (2) Baricitinib (Phase 2, Rheumatoid Arthritis): Expectations could rise to close to $750MM to $1Bn (from currently ~$300-400MM) before the end of the year on the back of positive data release at a medical conference in November and announcement of a phase 3 trial initiation prior to the end of the year, (3) Ramucirumab (Phase 3, Breast cancer, 4Q): Release of phase 3 data for this generally under the radar asset in lucrative breast cancer indication could materially raise peak estimates from current range of ~$350MM, particularly since it has active programs in several other indications.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.