What do you call a stock that trades for less than the book value of the assets on its balance sheet? In a word, cheap. Such stocks are relatively rare, but they can be found.
The three cheapest healthcare stocks on the market right now with a market cap of at least $250 million based on price-to-book are Community Health Systems (NYSE:CYH), PDL Biopharma (NASDAQ:PDLI), and Mallinckrodt (NYSE:MNK). But are these cheap stocks smart picks for investors, or are they value traps?
Community Health Systems
Community Health Systems stock trades at price-to-book of 0.51. However, that's one of the few appealing things about the hospital stock -- at least for now.
The company owns, operates, or leases 127 hospitals in 20 states. Community Health Systems stock enjoyed a nice run during the early years of Obamacare, but has plunged nearly 90% since July 2015. Community Health's top and bottom lines have deteriorated. The company lost $1.7 million in 2016 and was in the red again last year, losing $446 million in the first nine months of 2017.
Why does Community Health Systems have such a low price-to-book ratio? One major reason is that the company carries over $6.1 billion of goodwill on its balance sheet, thanks to multiple acquisitions over the years. Without this goodwill, the stock wouldn't look so cheap.
Still, some investors seem to think Community Health Systems' future looks brighter than its recent past. In January, large investment management firm BlackRock, the second largest shareholder in Community Health Systems, added more than 1 million shares to its position. The hospital operator's largest shareholders, Shanda Group, also increased its stake in Community Health Systems earlier this year. Largely as a result of these moves, Community Health Systems stock is up close to 30% so far in 2018.
PDL Biopharma stock currently trades at 0.45 times book value. The biotech royalty company also looks inexpensive using a couple of other metrics, with shares trading at less than 5 times trailing-12-month earnings and PDL claiming a low price-to-earnings-to-growth ratio of 0.25.
One thing that really jumps out when you look at PDL Biopharma's financial statements is that the company has more cash than it's currently worth. PDL's cash, cash equivalents, and short-term investments as of Sept. 30 stood at $516 million. The company's market cap is around $373 million.
It's likely that PDL Biopharma will use a significant amount of its cash in the future, though. Because PDL's royalty rights that generated a lot of money in past years have expired, the company is now looking to make more deals to acquire commercial-stage products and make money from product sales.
PDL Biopharma stock performed well last year, with shares rising nearly 30%. The overall market pullback has weighed on the stock in 2018 so far, however. At least one investor continues to think highly of PDL. An artificial-intelligence-powered exchange-traded fund, the AI Powered Equity ETF (AIEQ), includes PDL Biopharma as one of its top five healthcare stocks.
Mallinckrodt has a price-to-book multiple of only 0.30. That makes it the cheapest healthcare stock right now, with a market cap of $250 million or more based on the valuation metric. The specialty-drug stock also looks cheap based on its forward earnings multiple of 2.3 and PEG ratio of 0.68.
It's been a rough stretch for Mallinckrodt over the past few years. Similar to Community Health Systems, Mallinckrodt stock has sunk close to 90% since July 2015. Much of the company's problems have stemmed from declining sales of its specialty generic drugs in the wake of customer consolidation and increased generic drug approvals exerting downward pressure on prices.
However, Mallinckrodt also faces challenges for its specialty brand drug, Acthar. The drug has generated controversy, since it once sold for $40 per vial but now is one of the most expensive drugs on the market. Despite the controversy, until relatively recently sales for Acthar were growing fast. However, Mallinckrodt is now experiencing lower sales volumes because of what the company says is "an increasing number of written prescriptions going unfilled due to the challenging reimbursement environment."
Mallinckrodt's could face another headwind: a potential threat from Amazon.com, Berkshire Hathaway, and JPMorgan Chase. In January, the three companies announced plans to create a new non-profit company to deliver "simplified, high-quality, and transparent healthcare at a reasonable cost." If successful, this effort could disrupt healthcare and especially affect generic-drug makers like Mallinckrodt.
Bargains or busts?
Although a couple of its major investors appear to have confidence in Community Health Systems, I think there are definitely better stocks to buy than the hospital operator. In my view, the stock isn't a big enough bargain to make it worth the risk. I think the same is true for Mallinckrodt. The drugmaker simply faces too many challenges.
PDL Biopharma, on the other hand, is intriguing to me. The company appears to have made a smart move by acquiring Noden Pharma in 2016. This deal gave PDL rights to blood pressure drug Tekturna, which currently generates roughly one-fourth of PDL's total revenue. More transactions like this one could help PDL Biopharma grow in the future.
And with more cash on hand than the company is currently worth, there's a nice margin of safety with buying PDL stock. This bargain healthcare stock looks like a buy, in my opinion.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Keith Speights owns shares of JPMorgan Chase. The Motley Fool owns shares of and recommends Amazon and Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.