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Preventative Medicine In The Obama Era

Posted: Nov 26, 2008 15:30 PM by Ryan Barnes

Tickers in this Article: DGX, BEC, BDX

Healthcare is a sector that certainly deserves a minimum of a market weighting in your equity portfolio. But where to go in the sector? Pharmaceutical stocks, although currently cheap on the basis of earnings multiples, could face severe pressures from a Democrat-controlled White House and Congress.

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Shares of health insurers have been creamed in 2008, and will remain on shaky ground until credit crisis fears recede. The areas that really stand out to me are diagnostics and devices. These segments have solid margins without getting to the point of ostentatious (i.e. Big Pharma) and could see less pressure from the government to negotiate price cuts with Medicare and Medicaid. (To learn more, read What's The Difference Between Medicare And Medicaid?)

Diagnostics, Early Detection Systems Reduce Medical Costs
Preventative medicine, as a general theme, is likely to see a bit of a rallying cry as the new Administration seeks to reform the healthcare system. Companies that can offer evidence that their products and services reduce long-term medical costs through early detection and treatment should be prominent on our investing radars.

Faster, more accurate diagnosis of life-threatening diseases like cancer or diabetes is crucial to ensuring the most effective response. The earlier things are caught, the cheaper medical costs will end up being, an overall benefit in the eyes of Medicare/Medicaid and health insurers.

The three companies highlighted below each serve the medical community in crucial and cost-saving ways. Until recently they had been steady gainers, as long-term demographic trends point to an aging population and developing economies seek broader access to medical care. (Learn more about investing in this sector, in our related article Investing In The Healthcare Sector.)

Supplying Medicine's Picks and Shovels
Becton Dickinson (NYSE:BDX) is a $15 billion market cap provider of both medical supplies and diagnostic products. Becton earns more than half of its revenue from the sale of industry-leading supplies like syringes, needles and scalpels. Diagnostic products contribute about 30% of revenue, and Becton also has a Biosciences segment that provides equipment to biotech researchers of new drugs and studies.

In the most recent quarter, BDX reported a 15% rise in profit on 11% top-line growth. Operating margins expanded by 90 basis points to 21.7%, while operating cash flow in the past year was a strong $1.7 billion.

Shares are off about 25% year-to-date, far outperforming the 40% drop in the S&P 500. Sales are forecast for single-digit growth in 2009, but currency fluctuations could affect results as the company generates a large portion of sales overseas.

Quest for Profits
Quest Diagnostics (NYSE:DGX) is, as the name suggests, quite focused on diagnostics. Quest operates more than 2,000 testing centers around the globe conducting basic testing services for things like diabetes and cholesterol, and has recently moved into growth areas like genetics-based testing and outpatient treatment services.

Quest is also embracing a new relationship with Google Health to provide patient results online; this is just the type of advancement that President-Elect Obama has repeatedly noted will be a focal point of his healthcare reform.

Earnings per share were up 12% in the last quarter, and Quest CEO Surya Mohapatra sees a clear path to continued strong growth, nothing that "diagnostic testing is a large and fragmented industry ... We have only 15% of the market, leaving plenty of room for growth."

The company has a higher debt load than you'll find in most competing firms, but Quest has ample interest coverage and was able to grow operating cash flow in each of the past two quarters. Shares are down about 18% on the year, again a strong relative performance compared to the S&P 500. (This sector can provide huge gains, but can also have a downside. LEarn to protect your investments, in The Ups And Downs Of Biotechnology.)

Beckman Coulter Leveraged to Biomedicine
Beckman Coulter (NYSE:BEC) is a supplier of biomedical testing and instrument systems to hospitals, pharmaceutical companies, university research centers and biotech drug developers. Beckman's products are involved in finding the causes of disease, identifying new therapies and testing their efficacy in patients.

More than 75% of company revenue is recurring, coming in the form of upgrades, supplies and test kits to existing base of over 200,000 installations. In the most recent quarter, total revenue was up 13.4%, while recurring revenue was up 10.4%. Long-term trends toward genome-led therapies should provide Beckman Coulter with even more opportunities to leverage its existing customer base, while government grants and other private stimulus are likely to grow in an Obama Administration.

Shares are down 40% YTD, more a reflection of a previously high 20+ earnings multiple than deteriorating earnings prospects.

Parting Thoughts
Healthcare as a sector may provide mixed returns going forward. Certain companies may be under pressure to transform their business models away from high margin, patent-protected products. But companies focused on diagnostics, early treatment and lowering total long-term medical costs could see higher demand from both private and public sectors.

Do you have a favorite healthcare stock? Will President Obama spend big on preventative medicine initiatives, or is Big Pharma the place to be in 2009? Join me in the Investopedia Community (EpiphanyOne) to discuss your views and make your stock picks for all to see.

By Ryan Barnes

Ryan Barnes has over 10 years experience in portfolio management and investment research, covering equities, fixed income and derivative products. Barnes has worked with Merrill Lynch, Charles Schwab, Morgan Stanley and many others as an institutional trader, and maintained AIMR compliant performance for a diverse set of high-net-worth investors.

Barnes is currently working as a writer and financial modeling consultant specializing in capital appreciation and hedging strategies, and is the editor of EpiphanyInvesting, a website devoted to finding long-term success in the stock market.

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