IHI: Medical Devices Make a Momentum Comeback

In the last few months of tough stock-market sledding, one of the tried-and-true axioms of investing has come to the forefront: The health care sector is a good place to hide during bear markets.

Over the last three months (through Aug. 8), seven funds in our ETF Momentum Tracker universe have posted positive returns, and six of them focus on health care. While iShares Dow Jones US Medical Devices (IHI) doesn’t top that list (iShares NASDAQ Biotech (IBB) does), IHI has been on a roll, with a three-month gain of 9.67% that beat the S&P 500 by more than 16 percentage points.

The sector didn’t survive the difficult first quarter unscathed (IHI lost 11.1% year to date through March 10), but it wasn’t stung as badly as the broader market—the S&P 500 fell 13.86% in that period—and has rebounded strongly this summer, gaining 13.4% since March 10. Since May 20, IHI climbed 16 spots up our ETF Momentum Tracker Sector Momentum Table, hitting No. 10 last week.

While IBB, which we added to the ETF Momentum Tracker portfolio on July 23, may offer a better chance for major, rapid gains, IHI has shown a slow and steady resilience that stands out in turbulent times.

Pharmaceutical firms can face increased competition from generics when consumers are pinching pennies, and managed-care firms may see profit margins shrink when operating costs rise, but firms that manufacture medical equipment often remain cushioned from such factors.

An aging population and fast-growing international markets have kicked up demand for many cardiovascular and orthopedic devices as well as key products for patient care and diagnosis, according to Morningstar analyst Harry Milling. All those items are made by the device makers represented in the IHI portfolio.

The fund tracks the Dow Jones U.S. Select Medical Equipment Index, taken from the largest 2,500 U.S. stocks and weighted by market cap. The largest medical device makers are based in the U.S., but the fund gives access to global markets, including rapidly growing emerging areas. Many got a boost from the weak dollar in recent months.

IHI top three holding Thermo Fisher Scientific (TMO), for instance, brings in more than a third of its revenues from outside the U.S. and aggressively markets its products in India and China, where it has been moving much of its manufacturing as well. Recently, the firm reported that “currency translation” added 4% to its second quarter revenues. Shares are up 8.4% in a month.

Moreover, medical professionals typically guide the purchasing of medical devices through advising patients or direct buys. They tend to favor firms with which they have ongoing relationships, especially because their products can be unique or require a significant amount of training for doctors and nurses, Milling says.

While barriers to product switching and strong client relationships may not fuel immediate stock returns, they can help insulate the industry from broader economic cycles.

IHI typically invests around 60% of its assets in its top 10 holdings, which have recently included Covidien (COV) and Varian Medical Systems (VAR), whose stocks have gained about 23% year to date (through Aug. 8). Covidien’s spin-off from Tyco (TYC) has been well-received by investors. Covidien offers a wide range of products, from imaging devices to safety syringes, but its product pipeline had begun to suffocate under the ownership of Tyco, which underfunded the firm’s R&D, according to Morningstar’s Alex Morozov. The fact that the firm has quickly upped its investment in product innovation since leaving Tyco leaves analysts optimistic, though the investment has also had a drag on profitability.

Varian announced fiscal third-quarter results that far exceeded expectations. The strong quarter was partially due to the firm’s successful release of the radiation therapy RapidArc, which has spurred intense demand. If the company’s positive outlook for the rest of 2008 and 2009 proves sound, it’s likely that the firm’s stock will rally further, even if the slow economy has some effect on earnings, Morningstar’s Bill Buhr said recently.

Indeed, the medical devices industry has been a safe haven during the recent market turmoil, but there are strong arguments for giving its stocks a place in one’s portfolio for the longer term.

IHI ties into key macro-economic trends such as an aging population and emerging economies, where more and more residents seek quality medical care. But medical equipment stocks offer something else, too: This narrow segment of the health care industry offers high potential for earnings growth, not unlike that of technology and other high-growth sectors.

S&P’s Robert M. Gold said he expects that the sector “will continue to grow in 2008 and 2009, regardless of more restrictive credit market conditions that may ultimately affect spending decisions at the hospital customer base.” And he cited “positive longer-term fundamentals” with 2008 revenues rising about 12%, according to businessweek.com. Combine that with the fund’s recent outperformance, and IHI is an ETF to watch, especially if IBB falters.

Comments

[covidiensucks:]

If you want to work for a company that will F you over, choose Covidien! A true nightmare company!

The imaging devision is terrible! There is not a person in the company not out looking for a new job. They raised the quotas on the sales force during the year twice. Once they raised it 4 months before the FDA approval for the generic heart agent. Now they've been delayed by the FDA for at least two months. Guess what? They have elected not to adjust the quotas. Every sales person in the entire company is so mad! I worked for them for over twenty years. It used to be a great job. Now it is below entry level medical sales. Most reps are in the 60-80 K range including bonus which is non-existent. They lie and tell you you'll make 125-200. It's all lies. It's the last place anyone in medical sales should consider.

The executives, by the way, are making money hand over fist. The stock is going through the roof because wall street sees great margins and low cost of doing business. They are raping their sales force. Most of my friends have not had a bonus in more than 8 months. They assured everyone quotas will be re-evaluated at the end of the fiscal year. They know they blew it but are unwilling to fix it. It's all about wall street and the stock. They assured the sales people they would be treated fairly months from now whenever they get around to it. Guess they are too busy spending all their bonus $$$$ as they rape the sales force.

If a recruiter calls you about covidien, run don't walk!

2008 Aug 16 01:10 PM