Happy holidays! What do a cancer drugmaker, a medical marijuana play, and an insurer have in common? They're among the best-performing healthcare stocks on the planet this year.
Exelixis (EXEL 3.08%), GW Pharmaceuticals (GWPH), and UnitedHealth Group (UNH 0.54%) have generated envy-inspiring returns for investors this year, and in this episode of The Motley Fool's Industry Focus: Healthcare podcast, analyst Kristine Harjes is joined by Todd Campbell to unpack the reasons behind their eye-popping performance. Can these top stocks continue their winning ways? Find out in the following video.
A full transcript follows the video.
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This podcast was recorded on Nov. 18, 2016.
Kristine Harjes: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. I'm Kristine Harjes, and after a couple weeks of not doing a show together, I'm pleased to have Motley Fool healthcare specialist Todd Campbell calling in. Welcome to the show, Todd!
Todd Campbell: Hi, Kristine! It's awesome to be back on the show together.
Harjes: Yeah, I'm excited. This show that you're listening to right now is going to go out on November 23rd, but we're actually pre-recording it. As I'm saying these words, it's November 18th. That's because Thursday, November 24th is Thanksgiving. We will not have episodes coming out either tomorrow -- meaning Thanksgiving, the 24th -- or Friday of that week, Black Friday, as most of the team is traveling and spending time with family. Hopefully, all of our stateside listeners are doing the same. With the holiday in mind, we wanted to share a handful of healthcare companies that have very thankful investors this year, because they're up a ton, and in general just talk about being thankful. It is the season, right?
Campbell: Absolutely. Kristine, in keeping with that, what are you thankful for this year?
Harjes: I have so much to be thankful for, but fresh on my mind, I just got back from a team lunch with the Fool.com editorial team. I am so thankful for the people that I work with. They make everyday a joy, and they are fantastically competent, and they challenge me every day, and it's an amazing team to work with.
Campbell: It's a great group of people, there's no getting around that. If you're not at The Fool or involved with the Fool, you can't fully appreciate just how awesome these people are.
Harjes: We have a really good time. (laughs) Yeah, every day is something different. What about you, Todd? What are you thankful for?
Campbell: Maybe I've told you and the listeners this in the past, my oldest son is in the Navy, and he's been stationed overseas. He just came back home. He's home for a month. So, we're going to be able to enjoy a nice turkey dinner with everyone at the table this year, and we're very thankful for that.
Harjes: That is amazing. What is the food that you're looking forward to the most? This is probably the most important question I'll ask all day.
Campbell: There's so much good stuff on our table, but I'll admit I'm a sucker for good old-fashioned gravy and stuffing and turkey, just the basic stuff.
Harjes: Oh, my gosh, yes. I'm so full from this lunch, and yet I'm still drooling, I love Thanksgiving food. (laughs)
Campbell: All of our listeners --
Harjes: (laughs) Yeah, we're probably making you guys hungry.
Campbell: Or, they're all travelling right now --
Harjes: Yeah, on their commutes home.
Campbell: -- to their families' houses, and they're like, "Yeah, I know, we're not there yet, Todd and Kristine. We're starving."
Harjes: Maybe people are listening to us while they're eating their turkey. Don't do that, talk to each other, fight about politics or something. Anyway, let's get to the turkey of this show, the meat of this show -- that was horrible. (laughs) We wanted to talk about some healthcare companies that are up very substantially year to date. The first one, I believe, is from your mid- to large-size healthcare companies on the major U.S exchanges, the best performer year to date, it's up around 200%. This is Exelixis.
Campbell: Right, it's a mid-cap stock now, but it wasn't when you started the year, was it? Maybe that's one of the things that investors are going to be so very thankful for over the course of the past year, because if there was one stock that certainly suffered some pain in 2014 and the first half of 2015, it was Exelixis. This stock got absolutely hammered. I think it was trading about $7 at the peak in 2014, and fell to as little as $1.50 at the start of 2015. Just a really brutal period. And, boy, how things have changed in 2016.
Harjes: Yeah, they really hit their stride this year. They essentially took flight commercially. This is a company that has two drugs, but they're kind of the same drug. The drug itself is called, chemical name, cabozantinib, and it sold under two different names. The first one is Cometriq, and the second one is Cabometyx. The first one, Cometriq, has been not doing the best.
Campbell: Yeah. It treats a tiny indication. It's been on the market since 2012. Last year, it brought in -- I don't want to call it a rounding error... it's not insignificant -- but $37 million.
Harjes: When you're talking about the world of biotech companies, $37 million is a pittance of a sum.
Campbell: Yeah. It certainly wasn't a stock that would move the needle. And I think that's one of the reasons this stock got hit so hard not that long ago, because they had been doing a study to try to expand it into prostate cancer that fell flat. After that happened, it cast a lot of doubt on whether or not this drug would be able to be expanded into other indications. A lot of people walked away on that news. Yet, that would have been a big mistake, because late last year, they reported great results in kidney cancer trials, and in April, they won FDA approval for use as a second- and third-line treatment for advanced kidney cancer cases.
Harjes: And this is Cabometyx.
Campbell: Right. It's the same drug, but sold under two different brand names. It's a slightly different formulation. I think Cabometyx is a tablet, versus the other one, which is a capsule. I'm not 100% positive about that.
Harjes: The sales we mentioned for Cometriq -- which, remember, are pretty insignificant -- was $37 million in all of 2015. Meanwhile, Cabometyx, if you look at just its first full quarter on the market, which was the third quarter of this year, it sold $31.2 million.
Campbell: We're already at $120 million annualized run rate, in the first quarter post-launch. (laughs) That's a pretty significant catalyst for shares having head higher. Exelixis management has been very vocal this year, they think they can get a lot bigger on this drug. Not only do they think they can win more market share in the second- and third-line setting, but they also think they can win market share in the first-line setting, displacing Pfizer's Sutent, which is a $1 billion drug in that setting.
Harjes: Right. This is a fairly competitive indication, kidney cancer. You have Pfizer's Sutent as the standard of care. You also have Bristol-Myers with Opdivo, you have Novartis, they have a drug called Afinitor. Right now, Cabometyx has a 20% market share as the second-line treatment for kidney cancer. They also have 35% as a third-line treatment, meaning after you have tried two drugs and they've failed. We recently got data that this drug beat the standard of care, Sutent, in the first line. So, going forward, you could see them start to win some market share away from this billion-dollar blockbuster drug.
Campbell: It hasn't been approved yet, Kristine, so we have to remind that to investors. There's the caveat: it hasn't been approved for that yet.
Harjes: Yeah. So, it's something to look for.
Campbell: It's hard to imagine, honestly, that they wouldn't approve the supplemental application. If so, then next year is when we'll start to see the tailwinds from that. We're talking, this could add hundreds of millions of additional dollars in sales to the company in 2017. I don't think the jury is out that this move in the stock is over, despite the fact that you're already talking about a company that has a $4 billion-plus market cap, despite only having, adding everything together, $160 million, roughly, in sales.
Harjes: Right. This company does feel to me like they're just at the beginning of their journey. One thing I will put up as a word of caution, Opdivo, which is the Bristol-Myers drug, we've talked about this on the program, that's also being studied versus Sutent in the first line. We'll get data for that probably in 2019. At that point, I'm not sure if I would want to be competing against Opdivo.
Campbell: Just to make this even more confusing for investors, there are actually combination studies going on right now evaluating the use of Opdivo plus Cabo. So, who knows how this is going to shake out over the course of the next three years or so? But, it is an important market, and there are a lot of sales up for grabs.
Harjes: Exactly. All in all, this is definitely a stock that went from extremely high risk to slightly less risky. They now have this one drug on the market, and they have cash and equivalents of about $380 million at the end of the third quarter. They're expecting another $85 million in milestones later this year. They seem like they might be just heating up. But it remains a story to watch.
The second company we wanted to talk about today is a company in that is up 70% year to date, which, while not as good as 200%, I would still take that and be very thankful for it.
Campbell: Are we going to use the M-word, Kristine? (laughs)
Harjes: Are we? Do you want to go for it?
Campbell: The marijuana! (laughs)
Harjes: Yes, this is a marijuana stock. (laughs) It almost makes me cringe to say that, because we have said so many times on here that there are no good marijuana stocks to invest in, or hardly any. But this stock is kind of an exception to the rule. It's a legitimate company, which you can't say about 99% of marijuana stocks. Its name is GW Pharmaceuticals.
Campbell: Right. Shares have increased by more than 80% this year. A little bit like the stock we were just talking about, last year, 2015, was a tough year for the company. They were conducting studies, basically evaluating the use of cannabinoids, or the chemical compounds found in marijuana, to treat various conditions. Last year, they had huge studies in cancer pain fall flat, which made a lot of people -- including, admittedly, myself -- very doubtful that they would be able to deliver positive trial results in 2016 in some of these other indications they were evaluating. And I was wrong on that.
Harjes: This is actually such a parallel with the story of Exelixis, where they had this one drug, Sativex, that had hardly any sales, and they tried it in cancer pain and it failed, and people started to doubt them. And then you had this huge "but," where all of the sudden, they try something else and it really works.
Campbell: Yeah, "but ..." And that "but" is a drug called Epidiolex. How should we pronounce that?
Harjes: That sounds great to me. I'm thankful for our listeners' forgiveness for our pronunciations.
Campbell: That drug is a formulation of the cannabinoid CBD. Sativex is THC, which is the psychoactive ingredient in marijuana, and CBD is the non-psychoactive ingredient. What they evaluated Epidiolex in was Dravet syndrome and Lennox-Gastaut syndrome, which are two rare forms of epilepsy that are exceptionally hard to treat. Patients participating in these trials failed on an average of seven anti-epileptics before turning toward this drug. And yet, despite it being tough to treat, patients participating in this trial who were given this drug saw 40%, roughly, reduction in monthly seizures, which is a tremendous potential improvement over what patients are enduring today in these indications.
Harjes: Absolutely. This drug had a couple of different spikes throughout the year. One of them came just recently after the election. Healthcare as a whole, especially biotech, got a big boost from Trump winning the United States presidency. Do you think that was warranted with GW?
Campbell: No. GW Pharmaceuticals isn't selling their drug through medical dispensaries. These are FDA-quality pathways that they're approaching the market through. These medicines would be prescribed by doctors, filled at regular pharmacies. They would be FDA-approved for use in these indications. Whereas, with medical marijuana, treatments are not as vetted and proven scientifically to deliver these kinds of benefits. That doesn't mean that GW Pharmaceuticals, if Epidiolex is approved, wouldn't face competition from patients who may decide to go in and buy Charlotte's Web, which is a very high-CBD strain, through a dispensary. But it's not really a direct line of sight, in my view, between the votes we saw on the 8th approving medical and recreational marijuana in a number of states and GW Pharmaceuticals' ultimate success or failure.
Harjes: Makes sense. [...] Todd, are you ready to talk about our third and final stock that healthcare investors should be thankful for this year?
Campbell: Absolutely, and this one's going to be a little bit different, because we're not talking about two smaller stocks that doubled or more, we're talking about a giant in healthcare. That company is UnitedHealth Group.
Harjes: Yes. This is the largest health insurer in the United States. It's been steadily climbing higher all year. It's up about 27% from January 1st.
Campbell: Yeah, a huge move, and huge out-performance for a big-cap stock versus the S&P. What's interesting about this company is, similar to the other two companies we talked about, there were a lot of reasons to have some concerns going into the beginning of 2016 with UnitedHealthcare. They had just come out of December saying, "We think we're going to lose hundreds of millions of dollars on Obamacare-offered insurance plans this year, and that's going to be a drag on what we think we can deliver în EPS (earnings per share)." At the beginning of the year, I think they were forecasting about $7 in earnings this year. Boy, they lowballed that, because their performance this year is much better than that. Of course, with the outcome of the election, there are a lot of people thinking they could have significant tailwinds if Obamacare is completely rolled back.
Harjes: Right, exactly. Obamacare could be a good thing and a bad thing for this company. We were talking earlier about Obamacare and how it relates to UnitedHealth, and you mentioned it could be a headwind to their Medicaid segment, but a tailwind to their individual market segment. Could you unpack that a little bit?
Campbell: Yeah. Their fastest-growing piece of their business has been the Medicaid part of their business. That's essentially where they run state Medicaid programs. If you go back in the way-back machine and start thinking about, what did ACA/Obamacare do? One of the things that Obamacare did is allow states to opt into Medicaid expansion. 30+ states chose to decrease the qualification criteria for Medicaid, allowing millions more people to come onto the Medicaid rolls. That has actually been very profitable for UnitedHealth and many others. That's something we're going to have to walk very carefully as investors, because while on the surface, we may say, "Wow, there's a lot about Obamacare that is a drag on profitability," there's a health insurance fee that gets charged to health insurance companies for participating in the market place. This year, I think that fee is going to cost UnitedHealth Group about $1.8-1.9 billion. You have the losses that are, theoretically, going to trail off now, from offering those plans in those states. And you also have deregulation that could free them up as far as pricing and how they insure and who they insure, that could provide tailwinds. And then some of that will be offset, potentially, by this Medicaid side of the business.
Harjes: Exactly. Something that is important to watch out for with UnitedHealth is called the medical loss ratio. The government mandates that at least 80% of the premiums that an insurer collects be paid out then for healthcare costs and quality improvement activities. So then you only have 20% of that premium money left over to pay for your administrative, your overhead, your marketing, all of the things that form your operating cost ratio. Then, after that, that's what you have left as profit. So, as an investor, when you're looking at this company, what you want to see is, that 80% is essentially what you're at. You don't want to be too far from that 80%. You also want to see your operating cost ratio be pretty low. On both of these measures, UnitedHealth has done very well, something like 80.3% of their premiums --
Campbell: That's exactly what it is, Kristine -- 80.3% on the cost ratio. They're coming right in as low as they can on that.
Harjes: And that's really great for this company. They also have a couple of other really awesome things going for them, for example, their Optum segment is growing like a weed. This was something that we knew going into 2016, that this would be an important business segment. Probably the most important part of it of all is the PBM, the pharmacy benefits management part of it, which is called Optum Rx. Back in 2015, there was an acquisition of Catamaran PBM. We knew that was going to give them some economies of scale. We're starting to see that hit, where the Optum segment is truly taking off.
Campbell: Yeah. Healthcare data analytics is a huge area for Optum and a huge potential growth driver. They deal with so many patients, and they have so many data points that they can leverage to try and figure out how to cut costs out of their system, how to treat patients better, that it should provide tailwinds throughout the industry. Especially since health insurance and health provider costs aren't going lower, they continue to trend higher. So the need for these kind of technology innovations still remains very high for this industry.
Harjes: For me, at least, looking at the three companies we talked about today, UnitedHealth seems like the best buy at them all. It's maybe not as red-hot as the other two are, but it is strong, steady and growing. What do you think?
Campbell: I think, especially if you're an income investor, because it is the only one of the three that actually pays a dividend --
Harjes: It's a solid diffidence, it's 1.64%, that's on a 32% payout ratio. That's two thumbs up.
Campbell: That's not bad at all, especially for a company whose share price just climbed 30%. That's good, too. So, yes, for income investors, absolutely. If you're a little bit more growth-oriented, you have a little bit longer time horizon, maybe I would lean a little bit more toward Exelixis, only because they have a chance to turn profitable next year. I think the estimated loss for next year by analysts is about $0.02. So, there's a chance that if they overdeliver over the next two quarters that they could actually start to break even next year. Obviously, that could create some excitement there.
Harjes: That's a great point. In wrapping up, I want to remind our listeners -- and our readers -- about a very special offer we're putting together. We'd like all of our listeners to write in with their favorite investing books that they know of, or any book that's helped them shape the way they think about economics, or the market, or how you make your decisions. Please shoot us an email at [email protected]. We're going to compile the list, and we'll send it out to everybody who writes in, and we'll do another pitch once we have the list, to see if anybody just wants to mooch off of everybody else's recommendations. Hopefully, that'll be a nice way to close out your 2016.
Todd, thank you so much. I hope you have a lovely Thanksgiving, and same to all of our listeners. As always, people on the program may have interests in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. For Todd Campbell, I'm Kristine Harjes. Thanks for listening and have a wonderful Thanksgiving!