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These 5 Healthcare Stocks Are Ridiculously Cheap

By Cory Renauer – Jul 25, 2016 at 4:03PM

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Looking for bargains in the sector best positioned to ride aging demographic trends? These five are screaming buys.

Image source: Getty Images.

The stock market offers opportunities every day, but healthcare is easily the sector benefiting most from the trend of aging demographics in the U.S. and throughout the developed world. This helps explain how over the past decade, the iShares S&P Global Healthcare ETF has outperformed the benchmark S&P 500 by more than 20%.

Zoom in to the past year, and you'll notice the healthcare index plunged as election-year drug-pricing concerns cast a shadow over the sector. It has recovered somewhat in recent months, but there are still some unbelievable bargains. Highly profitable companies AmerisourceBergen (ABC 1.31%), Aetna Inc. (AET), Cardinal Health (CAH 0.65%), Express Scripts (ESRX), and Gilead Sciences (GILD 0.98%) are all trading at ridiculously low prices.

Let's take a closer look at these five to see if any belong in your portfolio.

1. AmerisourceBergen: distributing drugs -- and profits

Following a deal with Walgreens Boots Alliance, AmerisourceBergen is better positioned than ever to post steady gains as an aging America becomes increasingly reliant on the prescription drugs it distributes. The tie-up with America's largest retail pharmacy chain gives AmerisourceBergen tremendous leverage to negotiate, and a recently announced three-year extension should allow it to continue through 2026. 

Of course, this advantage didn't come free. To close the deal in 2013, AmerisourceBergen offered Walgreens warrants to purchase about 22.7 million shares of its stock at $51.50 beginning this March and the same number of shares at $52.50 again next March. These warrants would have shrunk shareholders' slice of future profits, but the increasingly profitable company has been using its positive cash flows to keep its share count headed in the right direction.

ABC Revenue (TTM) Chart

ABC Revenue (TTM) data by YCharts.

Since the beginning of the Walgreens partnership, trailing free cash flow has risen about 195% to $3.6 billion. At recent prices, the stock is trading at just 5.4 times trailing free cash flow and about 12.5 times trailing earnings. Throw in a well-funded dividend that has been raised for 11 straight years and currently yields about 1.6%, and this healthcare stock's recent price seems absurdly low.

2. Aetna: profitable without Humana

Following rumors that the Department of Justice (DOJ) will try to block Aetna's acquisition of Humana, Aetna's future is far less certain than AmerisourceBergen's. Combined, Aetna and Humana have reported trailing revenue of about $115.2 billion. Excluding the Medicare Advantage plans that the companies would presumably sell in order to assuage antitrust concerns, the combined company would still have a smaller footprint than UnitedHealth Group, which reported $160 billion in trailing revenue.

Before you turn your back on Aetna, you should know that under the terms of the merger, Aetna and Humana must fight a DOJ lawsuit to block the deal. It's also important to note that since implementation of the Obamacare exchanges at the beginning of 2014, the company has become increasingly profitable.

Even though the company is so "small," Aetna's trailing free cash flow has more than doubled since the end of 2013 to about $3.8 billion. At recent prices, this healthcare stock is trading at just 10.7 times trailing free cash flow and about 14.5 times this year's earnings estimates. Whether the Humana deal goes through or not, Aetna looks incredibly inexpensive.

3. Cardinal Health: wholesale pricing

As the smallest of the big three wholesale prescription drug distributors, Cardinal Health might reasonably be expected to have the slimmest margins. On the contrary, the company's operating margin of about 2% over the past 12 months is wider than its peers'.

While Walgreens received a large equity stake in its distribution partner, CVS Health formed a 10-year joint venture with Cardinal Health that negotiates generic-drug pricing for the pair in return for 39 quarterly payments of at least  $25.6 million to the retail pharmacy chain. 

The added heft of America's second-largest retail pharmacy chain appears to be working in Cardinal Health's favor. Since the arrangement began about two years ago, trailing revenue has increased about 29% to $117.71 billion, and trailing free cash flow has risen about 20% to $2.75 billion.

At recent prices, Cardinal's shares are trading at just 10 times trailing free cash flow and 14.6 times this year's earnings estimates. With a rapidly rising dividend offering a yield of about 2.2%, this healthcare stock is a bargain.

4. Express Scripts: another big negotiator

Express Scripts also operates in a space where size confers an advantage that smaller competitors can't match. In this case, the pharmacy benefit manager represents healthcare plan sponsors responsible for about 85 million Americans' pharmacy benefits. In return for rebates and discounts, drugmakers can find their products on Express Scripts' preferred formulary, while refusing to haggle could land their product on its exclusion list.

Most importantly, Express Scripts isn't required to pass all the savings on to end payers -- a practice that one of its largest customers, Anthem, doesn't care for. The insurer has dragged the PBM into court in an attempt to reclaim around $3 billion in cost savings. I highly doubt Anthem will find success, but the market hammered Express Scripts, creating one of the best bargains in the healthcare sector.

Image source: Express Scripts.

Trailing free cash flow of about $5 billion is as high as it's ever been, allowing the company to return huge sums to shareholders in the form of stock repurchases. In the past year alone, it has lowered the number of shares outstanding by 11.4%, entitling investors to a much larger slice of future profits.

At recent prices the company trades at just 10.7 times free cash flow and about 10.5 times this year's earnings estimates. For a stock perfectly positioned to ride America's aging demographic trend, that's crazy cheap. 

5. Gilead Sciences: new peaks ahead

An estimated 180.6 million people worldwide are infected with one of six strains of the hepatitis C virus (HCV), and Gilead Sciences is the only drugmaker with an FDA-approved single-pill regimen for treatment of them all. 

Approved in late June, Epclusa can treat any HCV patient without costly -- and often unavailable -- testing to determine the virus strain. More importantly, with the exception of advanced cirrhosis patients, the treatment doesn't require adding poorly tolerated ribavirin to the regimen, an important feature that its competitors lack.

Image source: Getty Images.

When Gilead reported first-quarter results, sales of its leading HCV antiviral Harvoni fell about 15% from Q1 2015 to just $3.02 billion. Overall, first-quarter total product sales came in 3.7% higher than Q1 2015, at about $7.68 billion, but the market has priced the stock as if Gilead reached a peak it won't return to for many years.

Wall Street undervalued the company before, and I think it's wrong again. During the weeks following Harvoni's FDA approval less than two years ago, Gilead stock traded between 17 and 20 times trailing earnings of $6.15 per share, as the market couldn't make up its mind about how well it might perform. Since then, trailing earnings have nearly doubled to $12.03 per share, but the stock is inexplicably lower. At recent prices, Gilead shares trade at just 7.4 times trailing earnings, with Epclusa's scorch marks still smoldering on its launch pad.

All five of these healthcare stocks are ridiculous bargains, but Gilead Sciences is so cheap it's just plain silly.

Cory Renauer has no position in any stocks mentioned. You can follow Cory on Twitter @TMFang4apples or connect with him on LinkedIn for more healthcare industry insight. The Motley Fool owns shares of and recommends Express Scripts and Gilead Sciences. The Motley Fool recommends Anthem and UnitedHealth Group. 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.

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Stocks Mentioned

Express Scripts Holding Company Stock Quote
Express Scripts Holding Company
ESRX
Cardinal Health Stock Quote
Cardinal Health
CAH
$78.95 (0.65%) $0.51
Gilead Sciences Stock Quote
Gilead Sciences
GILD
$86.26 (0.98%) $0.84
Aetna Inc. Stock Quote
Aetna Inc.
AET
AmerisourceBergen Stock Quote
AmerisourceBergen
ABC
$167.70 (1.31%) $2.17
Walgreens Boots Alliance Stock Quote
Walgreens Boots Alliance
WBA
$41.66 (-0.24%) $0.10
Humana Stock Quote
Humana
HUM
$540.95 (0.49%) $2.65

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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