It's that time of the quarter again, folks: the filing of 13Fs with the Securities and Exchange Commission by institutional money managers with more than $100 million under management.
The release of 13Fs is highly anticipated because it gives Wall Street and Joe and Jane Investor an inside look at what some of the most successful billionaire money managers have been up to over the past quarter -- albeit, it's important that investors understand the data released is backwards-looking by a minimum of 45 days. Nonetheless, analyzing what the greatest investment minds are up to can lead us to identify possible trends, or stocks worth keeping our eyes on. Let's see what they were up to in the healthcare sector.
Billionaire money managers were selling big drug stocks in Q3
One trend that really stood out during the third quarter was that most big drugmakers had their positions cut by billionaire money managers. There were a few exceptions, with Merck (MRK 0.55%), for example, finding some buyers.
Merck makes cancer immunotherapy drug Keytruda, which looks the drug of choice in first-line advanced non-small-cell lung cancer (NSCLC) after Bristol-Myers Squibb's cancer immunotherapy Opdivo failed in first-line NSCLC. The resulting market-share swing could lead to improved profitability for Merck, and billionaire investors have recognized it.
Three other big drugmakers weren't as lucky.
Teva Pharmaceutical Industries
Among big drug stocks, Teva Pharmaceutical Industries (TEVA -1.05%) was quite a popular sell candidate. Five major hedge funds -- Glenview Capital Management, Highfields Capital Management, Paulson & Co., Pointstate Capital, and Viking Global Management -- all cut their stakes in Teva during the third quarter.
My suspicion is that two factors persuaded these billionaire money managers to head to the sidelines. First, most Americans fully expected Hillary Clinton to win the presidency. Clinton was expected to introduce considerably harsher legislation on drug pricing, which could have reduced their pricing power. While Teva is the largest generic-drug manufacturer, and it would presumably have benefited from a push to generic medicines, it also makes a considerable amount of money from its branded-drug businesses, which would have been hurt by Clinton's proposals.
There's also concern that Teva could struggle to integrate its $40.5 billion cash-and-stock deal that saw it acquire Actavis from Allergan (AGN). The deal makes Teva the undisputed largest generic drugmaker, but it took longer than expected to close and required Teva to sell off assets to appease regulators.
More recently, generic-drug producers, as a whole, were hit with a criminal investigation into possible price collusion. Charges against Teva and other generic drugmakers could be coming before the end of the year, further clouding their near-term outlooks.
Despite this laundry list of concerns, Teva is actually a company I added to my personal portfolio recently. Fundamentally, there's a lot to like, with the company valued at less than seven times next year's EPS and sporting a 2.8% yield. But it's really the synergies with Actavis that could lead to Teva's future growth. Purchasing Actavis should give Teva greater pricing power, and the cost synergies may allow for higher margins from its generic-drug segment.
Furthermore, Copaxone sales haven't tailed off as many pundits expected. Teva was able to use the courts to keep generic participants on the sidelines long enough to bring a new and more convenient formulation of its multiple sclerosis drug to market. This new formulation allows it to shuffle existing customers over to its extended-release formulation without losing much in the way of sales.
In spite of billionaires being pessimistic, I expect good things for Teva over the long run.
Another large-cap drugmaker that found itself on the billionaire chopping block in the third quarter was Allergan. A whopping 10 of 38 hedge funds we considered either parted ways with Allergan (Maverick Capital, Poinstate Capital, and Viking Global Management) or reduced their position (Adage Capital, Bluemountain Capital, Icahn Associates, Omega Advisors, Passport Capital, Paulson & Co., and Third Point).
As noted in the previous section of this article, part of this selling could be a result of the uncertainties surrounding the acquisition of Actavis by Teva. Allergan entered 2016 with more than $42 billion in debt, mostly as a result of its M&A-based growth strategy from the past couple of years. However, this debt was highly constrictive to its financial flexibility, meaning Allergan's management team sort of had its hands tied until the Actavis sale was completed. Since it took longer than expected, some money managers could have taken it as a cue to reduce their ownership or head for the exit.
Additionally, as we saw with Teva, money managers expected Clinton, not Trump, to win the presidency, and they were likely pricing in the potential for prescription-drug reform.
Were these billionaires right to sell Allergan? Part of me wants to say yes, considering that its established-brands business is weighing on its top line, and Alzheimer's disease drug Namenda XR had sales fall by a third from the prior-year quarter after formulary changes. Weaker all-around growth has translated into Allergan missing Wall Street's consensus EPS in two of the past three quarters.
On the other hand, Allergan's eye-care products, medical aesthetics, and Botox therapeutics seem to be unstoppable beasts. Allergan possesses strong pricing power on these products, resulting in segment margin of 55.4% in Q3. Allergan is also expected to generate north of $21 in EPS by fiscal 2019. If investors can weather the expected turbulence, then Allergan could present as an intriguing value stock.
Johnson & Johnson
Not even healthcare conglomerate Johnson & Johnson (JNJ 1.01%) was immune from the selling during the third quarter. Bridgewater Associates reduced its position in Johnson & Johnson, whereas Perry Corp. eliminated its position entirely.
The likely downside catalyst for J&J, as it was for Teva and Allergan, was the potential for prescription-drug reform with a Clinton presidency. Of the three companies mentioned here, Johnson & Johnson would likely have been the most at risk, considering its focus on specialty therapeutics, such as oncology and hepatitis C, which can carry five- and six-digit annual price tags.
However, the election of Donald Trump pretty much threw money managers' concerns right out the window. This isn't to say, though, that Trump will overlook the high cost of prescription drugs. In fact, during his campaign, Trump agreed with Clinton that something needed to be done to make prescription drugs more affordable. Trump's proposal, which was part of his seven-point healthcare reform, involves allowing Americans to purchase prescription drugs from overseas markets, such as Canada. Of course, making this work would involve major reforms at the Food and Drug Administration, which seem unlikely.
Money managers also appear to be overlooking J&J's well-diversified business model and strong pharmaceutical growth. Johnson & Johnson's three operating segments -- consumer health, medical devices, and pharmaceuticals -- are primarily inelastic because people can't choose when they get sick or what ailment they develop. This means J&J's business remains strong regardless of how well or poorly the U.S. economy is doing.
Johnson & Johnson may not be a screaming buy for value investors, but it's the slow-and-steady healthcare giant that can win the race for patient investors.