It's been a volatile first half of the year for the stock market, but the healthcare sector has really stood out as an underperformer. Specifically, drugmakers have taken it on the chin, with the SPDR S&P Biotech ETF plunging 17% year to date.
With the U.S. economy struggling to grow, value investors have proven considerably more critical of what they'll buy. Value investors simply aren't willing to pay a premium price for experimental-stage drug and device developers that could be producing losses for the foreseeable future.
However, the drop in the healthcare sector has also punished some very consistent and profitable healthcare companies. You could make a solid argument that a handful of healthcare stocks are now unbelievably undervalued. Here are three that you'd be wise to consider buying after this year's swoon.
The ironic thing about Ligand Pharmaceuticals (NASDAQ:LGND) is that its shares have bucked the overall trend this year and headed higher by 14%. Despite that gain, this nontraditional drug-developer looks like an exceptionally cheap stock.
Unlike most drugmakers, which make discoveries in the lab and put their drugs through a decade's worth of clinical trials, Ligand Pharmaceuticals is a royalty-based company. Ligand's Captisol technology, which improves the solubility and stability of select drugs, allows the company to receive a small percentage of revenue from the sale of every drug currently using its technology. According to Ligand's May presentation at Deutsche Bank's annual healthcare conference, 13 approved products are using Captisol, and more than 140 products being developed by over 85 drug developers are making use of Captisol. In other words, Ligand's chances to hit a home run are high, as it has a diverse array of partners using its technology.
Another aspect of Ligand that investors will love is its minimal overhead costs. Because Ligand isn't running extensive clinical trials, its expenses are substantially lower than those of most biotech companies. Its cost of goods sold in Q1 totaled 3% of revenue in Q1, and its relatively small staff means its general and administrative costs remain under control. Right now, Ligand's gross margin is above 50%, and it could push substantially higher as more drugs are approved that are using Ligand's technology.
Valued at a PEG ratio of just 0.8, Ligand looks unbelievably cheap.
Undervalued healthcare stocks aren't limited solely to drug developers, either. Select Medical (NYSE:SEM), a provider of outpatient rehabilitative care and an operator of specialty hospitals throughout the U.S., also looks inexpensive, with a PEG ratio that's just below 1.
The biggest catalyst for Select Medical has been the Affordable Care Act, which you likely know better as Obamacare. Health service providers such as Select Medical count on having their patients insured. Otherwise, Select Medical could be obliged to eat the service revenue as a bad debt expense. Before the introduction of Obamacare, it wasn't uncommon for hospital stocks to eat around 10% of their annual revenue as uncollectable.
Since Obamacare was introduced, uninsured rates have plummeted. Gallup's data from the first quarter showed that uninsured rates have fallen to 11% from 17.1% in the quarter before Obamacare's implementation (Q4 2013). Similar data from the Centers for Disease Control and Prevention showed an uninsured rate of just 9.1% as of the end of 2015, although this data includes Medicare enrollees. Low uninsured rates mean less chance of bad debt expenses and thus more profits for Select Medical. In Q1, Select Medical's bad debt totaled only $16.4 million, compared with $1.09 billion in net operating revenue.
Acquisitions are also fueling Select Medical's growth. Earlier this year Select Medical announced the acquisition of Physiotherapy Associates, an outpatient rehabilitation provider, for $400 million in cash. The deal proved to be immediately accretive to Select Medical's earnings, with revenue rising 37% in Q1 and net income improving to $54.8 million from $35.1 million.
So long as the uninsured rate keeps falling and the elderly population rises, Select Medical should be a smart specialty hospital-care investment to consider.
Finally, value and growth investors looking for an unbelievably undervalued healthcare stock would be wise to dig into Celgene (NASDAQ:CELG), which has come under fire in 2016 for its slightly lowered guidance for fiscal 2017. Despite its recent weakness, Celgene has a plethora of paths it can take to grow its business. These include organic, inorganic, and collaborative growth.
In the organic growth column, Celgene is reliant on its oncology and inflammatory drugs to do the talking. Multiple myeloma drug Revlimid continues to grow by more than 15% annually, which is a result of increased diagnoses, longer duration of use, and increased pricing power. Oral anti-inflammatory drug Otezla, a treatment for moderate to severe plaque psoriasis, is also marching toward blockbuster status, and multiple myeloma drug Pomalyst should build on its blockbuster sales in the years ahead.
Celgene is also making waves with its acquisitions, the latest being its $7.2 billion purchase of Receptos in 2015. Although Receptos has no approved therapies, the company's lead product, ozanimod, has delivered promising clinical data that could lead to approvals in treatment of multiple sclerosis and ulcerative colitis. At its peak, ozanimod could generate north of $4 billion in annual sales.
As icing on the cake, Celgene has partnered with more than 30 different companies to explore new and innovative oncology, immunology, and inflammatory therapies. Celgene could find itself on the line for substantial sums of milestone payments should these drugs succeed, but going the route of collaborating with multiple companies means Celgene is throwing its cash flow at only the most promising pipeline products.
A PEG ratio of 0.8, along with Celgene's 13% year-to-date dip, suggests it could still be unbelievably undervalued.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
The Motley Fool owns shares of and recommends Celgene, and has the following options: short October 2016 $95 puts on Celgene. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.