First off, I should confess that I have been completely wrong on the Gabelli Healthcare & WellnessRX fund (GRX), $9.65 market price, $11.09 NAV, -13.0% discount, 5.4% current market yield. I believed earlier this year that the mergers and acquisitions that were prevalent in GRX's portfolio and had fueled much of GRX's NAV and market price performance over the years would just continue, if not accelerate due to the quest for growth by companies that had limited organic growth opportunities otherwise. M&A activity in the healthcare and the food sectors was one of GRX's hallmarks for the past decade, and as a result, you would have been hard-pressed to find any equity CEF that had as good as NAV and market price performance than GRX.
At the time earlier this year, GRX's discount was still around -12% while most every other equity CEFs I followed were seeing dramatic discount compression if not market price premiums over their NAVs, so it seemed logical to believe that a fund with GRX's history and NAV performance, which at the time was still beating its benchmarks, should see some compression too.
Then, on June 16th, Amazon (AMZN) announced it would be purchasing Whole Foods Markets for $42/share, which just seemed like another buyout in a long list of GRX's top 25 holdings. So, imagine my surprise when by the end of the day, every other food stock in GRX's portfolio had turned decidedly negative and GRX's NAV barely closed up despite a roughly 30% bump in Whole Foods stock price (there was speculation another buyer might emerge driving Whole Foods stock price up higher than the 27% premium offered).
As it turned out, Amazon's buyout of Whole Foods was probably the worst thing that could happen to a fund which places foods and foods/staples retailing as its largest sector exposure, around 30% of the portfolio. Think stocks like Mondelez (MDLZ), Kelloggs (K), General Mills (GIS), Post (POST), Kraft Foods (NASDAQ:KHC), ConAgra (CAG), Dr. Pepper Snapple Group (DPS), JM Smucker (SJM), Campbell Soup (CPB) and the Kroger Company (KR). Even Whole Foods organic and natural foods supplier United Natural Foods (UNFI) was hard hit, down about -11% on the day.
Now, you might be thinking, "Why would all these companies even be in a healthcare fund in the first place?" The answer is that part of GRX's investment thesis is to focus on the trend towards consumers taking their health into their hands and making better lifestyle choices in what they eat and drink. This is the "Wellness" part of GRX's name and strategy, though I would agree that some of these companies are not exactly what you think of when you think of healthy foods.
Still, the threat of Amazon lurking in the food aisle and driving down product prices for all of these companies has brought their stock prices tumbling to 52-week and even multi-year lows. The following table of stock symbols from above shows their 52-week high/low range in the yellow highlighted box. The order of companies is by weighting in GRX's portfolio as of 6/30/2017, which certainly has changed since then.
Now, some large GRX positions in foods and personal care products like Unilever (UL), Nestle (OTCPK:NSRGY), Danone (OTCQX:DANOY), and Estee Lauder (EL), for example, are doing just fine, but still, it's pretty tough to stomach seeing this many large positions at 52-week lows when the broader market averages are hitting all-time highs day after day. This is a big reason why many investors are throwing in the towel on GRX, which has given up a lot of its gains this year and is up only 6.4% YTD on a total return market price basis. But now, there's another reason for the selling pressure too.
Now, Amazon Wants To Get In The Pharmacy Business?
If it wasn't bad enough, more recently, there have been rumors about Amazon looking to get into the pharmacy and drug distribution business by applying for pharmacy wholesale licenses in 12 states. This development just in the last couple weeks has knocked down another set of pins in GRX's portfolio, primarily the Prescription Benefit Managers, including GRX's largest position, CVS-Caremark (CVS). Other large positions that have suffered as well include drug distributors like AmerisourceBergen (ABC) and McKesson (MCK). Ironically, another prescription benefit manager, Express Scripts (ESRX), has actually gotten a boost as it is looked upon as a possible buyout candidate by Amazon.
Still, it seems like any company that has any involvement in the distribution of healthcare products; including vision care, medical supplies, or anything drug or device related that can fit in a mailbox, seems to be under duress as the shadow of Amazon looms overhead.
The Perfect Storm With The Captains Asleep At The Helm
I'm not sure I have ever seen a CEF portfolio more under fire than GRX's right now, and all due to one technology company that practically gives away everything it sells for little to no profit. It's ironic that GRX's strength in the past, i.e. diversification into two very defensive sectors now seems to be its Achilles' heel. 50% of GRX's portfolio is in healthcare stocks (i.e. pharmaceuticals, healthcare services, healthcare providers, etc.), and 50% is in consumer staple stocks (i.e. foods, beverages, personal products). Historically, this has made the fund more diversified and defensive than if it was only invested in a single sector like healthcare.
This can be seen in a list of healthcare/biotech CEFs, which shows GRX's NAV severely lagging the group so far in 2017, due primarily to the weakness in consumer staple stocks (XLP), but comparing a lot better if you go back even to just the beginning of 2016 when it was healthcare's (XLV) turn to lag. NOTE: The Tekla funds (HQH) and (HQL) are more biotech weighted than the other funds.
In fact, with biotechnology (IBB) down about -21.4% in 2016, the point I'm trying to make here is that a diversified portfolio like GRX's can generally ride out the ups and downs of certain sectors over the long run. And at a much wider -13% discount than the group, GRX's current market price of $9.65 is well below its NAV of $11.07 and already reflecting a lot of negative expectations.
Now, this does not excuse the portfolio managers of GRX whom I believe have done an absolutely horrible job of managing this fund over the near term. For example, one of GRX's largest holdings before it collapsed was Envision Healthcare (EVHC) which dropped -30% last Wednesday after their earnings release and is now down -57% YTD.
This is after the stock had been weak for some time, and I even questioned Gabelli as early as this summer why take a chance on EVHC with such a large position? As it turns out, this is not the first blow-up for the portfolio managers of GRX. Last year, as of 9/30/2016, Adeptus Health (OTCPK:ADPTQ) was a relatively large $4 million position in GRX at $43/share. By the end of the year on 12/31/2016, ADPTQ was at $7.64.
This is unacceptable. You can't have large positions like these blow up on you, particularly in a 23% leveraged CEF with $67 million in preferred share liabilities out of $287 million in total managed assets. Though the unrealized gains in GRX are still huge and the fund includes many winners up 100% or more from their cost basis, the portfolio managers have to be more attentive. Anyone could have seen that Envision Healthcare was a disaster waiting to happen, and the position should have been pared back substantially before earnings were released.
Buy Technology, Sell Everything Else
From a broader perspective, the strength of the market indices and particularly in large cap technology stocks is belying extreme weakness underneath in many sectors. I don't know if you have noticed, but blow-ups in individual stocks are just accelerating even as the markets hit all-time highs.
This is not a positive development. Investors have learned that large cap technology is the only sector you can rely on. Oh sure, other sectors may have their days or weeks when they're the hot dot, but when you get right down to it, everybody piles back into technology as the safe haven, much to the detriment of these other sectors.
Does anybody doubt that the technology sector will be the last pillar standing before we have a more serious pullback? It would probably be healthy for the markets, though it could also usher in a more prolonged and deeper correction based on the fear of rising interest rates, and a liquidity drain that I believe is starting to show up, though certainly not in the broader market indices. Still, I'm not so sure that a 5% or more pullback in the markets would not be the best thing that happened to GRX as this might get investors thinking that a rotation into down and out sectors is long overdue.
What Could Go Right
In the short term, the best thing that could happen to GRX and its positions in companies in the pharmacy and pharmacy benefit management space would be if Amazon decided it's not worth getting into their business. There are a couple reasons why Amazon may not want to make a full play into this space.
- First, it's one thing to transact business one-on-one with consumers. However, it's a lot more difficult when you throw in third party payers like insurance companies into the mix. Amazon would need to interface with these third parties in a seamless manner, and they may need to purchase companies that already have a presence in this space if they want to pursue this business.
- Second, Amazon makes it very easy to purchase items, which means the opportunity of abuse is escalated. Security is sometimes compromised when the goal is to maximize transactions or eyeballs. Look at the problems that Facebook (FB) and Google (NASDAQ:GOOG) (NASDAQ:GOOGL) are having with fake advertisements and articles intended to influence the hearts and minds of people and voters. They simply can't keep up with these abusers. Do you think buying prescription drugs online wouldn't be open to abuse?
- Third, Amazon may not want any more government scrutiny than what they already have. Washington is already concerned about the growing influence that large tech companies are having on the economy and indirectly, on politics. There's a growing consensus among government officials that Amazon's gain may ultimately be at the expense of more and more industries becoming obsolete.
Longer term, what could help companies that are being threatened with Amazon's intrusion into their business is simply the fact that Amazon will need to become more brick and mortar oriented while these companies become more online oriented.
That's right. The very thing that investors loathe about brick and mortar companies is exactly what Amazon is slowly becoming in an effort to get its name in front of a greater audience when not at their computer screens. Amazon may get billboard exposure with its Whole Foods purchase, but it also just became more of a space renter than a cyber-space free loader, and I doubt this will be its last brick and mortar company it buys.
On the other hand, traditional brick and mortar companies like Wal-Mart (WMT) and Target (TGT) are focusing on beefing up their own online business and competing against Amazon on its playing turf. These retailers will need to invest more in technology to enhance their online presence, which should result in better business efficiencies. On the other hand, we all know what can happen when companies try to grow too fast by expanding their footprint in more and more storefronts. I doubt if anyone other than Wal-Mart can match Amazon's pricing, but investors are so enamored with Amazon's business model that they look past any profitability. In Amazon's latest quarterly earnings announcement on October 26th, the company posted a 34% year-over-year increase in revenues, but profits were basically flat at $256 million. Still, Amazon's stock skyrocketed 13.2% the next day to close at $1,100/per share. In other words, 100 shares would cost you $110,000.
I'm not sure who has the advantage in morphing into the other's business model, but investors have certainly assumed Amazon is the clear winner. In the long term, I'm not so sure that will be the case.
What Could Go Wrong
In the short run, tax loss selling will probably limit the upside of many stocks in GRX's portfolio that are at their lows. This probably means this year is shot for any recovery although institutions that would consider re-initiating positions for next year will have until the end of this month to complete their sales.
Besides the perceived threat from Amazon, a more sustained threat is Federal and State involvement in the healthcare space. The Trump administration's failure to repeal the Affordable Care Act has only served to add uncertainty to what sub-sectors in healthcare to invest in. How will hospitals fare going forward, healthcare insurers, medical device makers? Some seem to be doing well, some not so much. Then, there's headline news regarding the opioid crisis and drug prices in general. All of this undermines the healthcare sector and makes it hard to know who the winners and losers will be.
Finally, with the markets at all time highs, there's little incentive for investors to rotate out of what's working and into down and out sectors. There would need to be some catalyst that brings a sustained rotation that lasts beyond a day or two. This could be a blockbuster deal, like the proposed CVS purchase of Aetna (AET) or something that knocks the technology sector out of favor, like anti-trust hearings or just more government scrutiny of how influential technology companies have become.
How Gabelli Can Bring Back Investor Confidence In GRX Again
The portfolio managers of GRX have certainly dropped the ball on GRX. I'm not here to tell them how to manage the fund, but I do think they need to pay more attention, and the Board of Trustees need to start putting investor interests first. Here are my suggestions:
- Realize that the sectors you invest in are under assault, not just from Amazon but also from Federal/State governments as healthcare costs are questioned and scrutinized. As a result, GRX's portfolio cannot be looked upon as a buy and hold like in years past. The portfolio managers are going to have to be more pro-active. When Merck (NYSE:MRK) can go from a 52-week high to a 52-week low in a month, you realize that there has been a sea change in what sectors to buy and hold and what sectors you have to trade around. Ironically, large cap technology seems to be the only sector you can buy and hold now. My, how things have changed.
- The winners keep winning and the losers keep losing. Trying to be a hero and picking up more shares of a losing position is not working. Adding to winners on any pullback and selling losers on any upswing is what institutional investors are doing either manually or by momentum algorithms, and until there is a more definitive rotation out of the few sectors that garner all of the buy interest, you have to go with what works. I realize this is a rather generic statement to make, but in a portfolio like GRX in which most positions are either at 52-week highs or 52-week lows (or even multi-year lows), you have to have your winners in the largest positions. Unfortunately, GRX is top weighted in losers like CVS, Envision Healthcare, and the large cap legacy food stocks. To me, it's better to reduce these positions and add to your winners like Abbott Labs (ABT), Johnson & Johnson (JNJ), Thermo Fisher Scientific (TMO), Cigna (CI), etc.
- Consumer staples and food stocks could be out of favor for some time. Amazon may just be a convenient excuse to sell, but growth prospects for large cap legacy food companies and retailers have been limited for a while now, hence all of the M&A activity prior to the Whole Foods purchase. GRX's portfolio needs to be restructured to lower this exposure and focus on smaller food and beverage companies that truly are involved in the "wellness" directive that the fund is supposed to follow.
- Avoid any more blow-ups. Envision Healthcare and Adeptus Health have cost the fund millions. The best road to recovery is not to take any more large risks but to build back the fund's NAV by investing in companies that may not have the upside potential but you know will be around for years.
- The lead portfolio manager, Jeff Jonas, either needs to focus more directly on the fund and the sectors that GRX invests in on or he is going to need more help. Trying to keep up with the changes in the healthcare sector is a 24/7 job for analysts by itself, let alone trying to cover two sectors. Mr. Jonas did step up and buy 2,000 shares of GRX in September at $10.06.
- Have a higher weighting in large cap biotechnology. Although biotech can be a minefield, at least it's a sector that isn't under threat from Amazon or under the microscope from the Trump administration. Biotechnology only represented 4.4% of GRX's portfolio as of 6/30/2017, and I believe this should be raised.
My (Strong) Feelings On Gabelli As A Fund Manager
Again, I'd like to apologize to anyone who took my advice on GRX earlier this year, not so much because of its poor performance, as sectors can go in and out of favor, but rather because of the neglect that Gabelli Asset Management or GAMCO has shown towards GRX and indeed, many of their CEFs.
What do I mean by this? GAMCO has done a wonderful job raising assets under management either through new fund issuances or new preferred shares or Rights Offerings for existing funds, but I now wonder how much of this was truly self-serving and not so much in the interest of their investors.
For example, look at the Gabelli Global Small & Mid Cap fund (GGZ). GGZ came public in June of 2014 at $12 and has been at a perpetually wide market price discount ever since. I built a fairly large position in GGZ and watched as nothing happened for months and even years. No distribution announcement, no news, and of course, no investor interest. It was as if it fell off GAMCO's radar all together. Then, in 2016, after I largely unwound the position, a preferred share offering raised $30 million for the fund. Congratulations Gabelli, more assets for more management fees.
Then, in 2017, GGZ finally started to take off, and as of this writing, GGZ's NAV is up a robust 20.5% YTD to $15.14. So, from a $12 inception NAV in June of 2014, GGZ's NAV is now at a very respectable $15.14. One would think that initial investors who have waited this long might be rewarded with the adoption of a distribution policy after 3 years. Right? Well, there was an announcement for GGZ on October 10th of this year, but it was for a Rights Offering and not any news of an initial distribution. Remember, more assets means more management fees for GAMCO. And, what happened to GGZ's market price discount on the Rights Offering news? It has now dropped back down to a -17.3% discount, the third widest of all CEFs.
GAMCO has certainly been adept at announcing offerings to improve its fee base. However, one thing that GAMCO hasn't improved on much is investor information available on its website. Whereas most other fund sponsors now offer monthly portfolio updates or at least offer something beyond what is required by SEC filings, GAMCO seems content to do the bare minimum to keep its investors informed. You want to know GRX's latest holdings? It will probably be later this month before you get a 3rd quarter update. Until then, you have to rely on information as of the end of June. How are you supposed to make informed decisions when you are left in the dark for four months?
And finally, you want to hear the latest news on the Gabelli funds? Check around their website and you will see their "latest" news releases can include announcements from as far back as 2013. I'm not sure what good that does investors today.
I first focused an article on GRX back in early 2012, When Opportunity Pounds On The Door, and I have written many articles on GRX since then. Back then, GRX had only a $0.10/share quarterly distribution, and it was a lot smaller fund than what we see today due to Rights Offerings and a preferred share offering, which raised an additional $112 million for the fund between 2013 and 2014.
However, on behalf of shareholders, there has really been no news or enhancements to the fund since then, except for a distribution increase from $0.12/share to $0.13/share in May of 2015. What kind of enhancements would I like to see? Anything that makes the fund more attractive to investors, which is more sorely needed now than ever before.
In past articles, I have pointed out GRX's extremely low NAV yield, which is still only 4.7% even after the NAV has dropped from a $12.13 high earlier this year to $11.09 today. Though a distribution increase is probably off the table now, there is no reason why GRX should ever have had one of the lowest NAV and market yields of any equity CEF.
But if not a distribution increase, how about the adoption of a minimum NAV distribution percentage each year like some of the other Gabelli CEFs? The fund doesn't need 10% like the Gabelli Equity Trust (GAB) or the Gabelli Multimedia fund (GGT). How about just a 7% NAV distribution policy? Or if that is too much to ask for, how about a monthly distribution frequency rather than quarterly?
I find it absurd to say this at a market high, but something positive needs to happen to trigger a change in sentiment towards these companies that have fallen under Amazon's shadow. We're not talking about small upstart companies that nobody would recognize if they faded away. We're talking about some of the largest and best known companies in the US and even the world.
Now, a lot of you may say that's just capitalism in motion, but I don't know how you can say this will be good for the economy in the long run. Amazon may be the great "vampire squid" of consumerism, sort of like what Goldman Sachs (GS) was described as an investment banker, but the difference is that Goldman Sachs spread its tentacles into everything it could make money at. Amazon doesn't even care about making money. It's all about volume and sucking dry other businesses so that they wither and die.
And, this is why I believe that ultimately, higher powers that be will realize that Amazon's business model is a zero-sum game, and this is why I believe Amazon's foray into the prescription drug business will only be half-hearted and eventually, they will withdraw from the space. We may find out soon if it pays to be a contrarian for once.
Disclosure: I am/we are long GRX, GGZ.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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