Despite the political blowback over drug prices in the United States, healthcare stocks have been steadily edging higher this year. One unfortunate consequence of this sectorwide upswing, though, is that most healthcare stocks are either fairly valued or flat-out overvalued at current levels.
Are there any compelling bargains remaining in the sector? We asked three of our Motley Fool healthcare contributors for their insight. They picked Heron Therapeutics (HRTX -5.36%), Illumina (ILMN -1.28%), and CVS Health (CVS -1.07%) as their top value plays in the sector right now. Here's why these three healthcare stocks might be worthwhile additions to your portfolio.
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Buy the dip
George Budwell (Heron Therapeutics): Heron's shares have taken an absolute beating this year as a result of the FDA's decision to reject the company's new drug application (NDA) for experimental pain medication HTX-011. However, the biotech's marked decline may represent an extremely attractive entry point for value and growth investors alike.
What's the skinny? HTX-011 is an extended-release formulation of the local anesthetic bupivacaine and the anti-inflammatory meloxicam, indicated for the prevention of postoperative pain. In clinical trials, the drug significantly reduced the need for rescue opioid medications following surgery -- a feature that could help it grab a sizable chunk of this multibillion-dollar market.
Wall Street's more conservative take on the drug has it generating around $545 million at peak, but more optimistic estimates put HTX-011's commercial opportunity into megablockbuster territory at roughly $2 billion a year in sales. Either way, this experimental pain medication should turn to be a tremendous growth driver for the company over the next decade.
Why did the FDA nix HTX-011's NDA? Even though Wall Street acted as if the FDA's decision was the end of the road, this initial rejection should turn out to be nothing more than a minor setback. After all, the agency simply requested additional chemistry, manufacturing and controls, and nonclinical information. That's not a show-stopper by any means. The point is that Heron should be able to get this NDA back on track within a matter of months, which bodes well for the prospects of a sharp turnaround in the company's shares in the near future.
Lighting up the field of gene sequencing
Keith Speights (Illumina): There are two things I really want in a stock. One is a strong moat. The other is optionality -- multiple paths to growth. I think Illumina has both.
Illumina currently dominates the gene sequencing market and has done so for years. Once an organization invests in one of Illumina's systems, it has a financial motivation to maximize the return on investment by using the system. That translates to higher consumable sales for Illumina. The company currently makes around 70% of its total revenue from recurring sources such as sequencing consumables.
This steady revenue enables Illumina to continually invest in research and development. Those investments lead to new technology, such as the NovaSeq system that the company launched last year. All of this makes for a pretty strong moat. Granted, Illumina has competition, particularly in the area of long-read gene sequencing. But Illumina's pending acquisition of Pacific Biosciences of California (PACB -7.48%) should shore up its weakness in this area.
What about optionality? Illumina has multiple avenues for generating growth. Non-invasive prenatal testing is becoming more widely used. Consumer genomics products such as those offered by Ancestry, 23andMe, and Illumina's own Helix spinoff are gaining popularity. Countries around the world are embarking on major population genomics initiatives. And gene sequencing is opening new doors in the treatment of cancer and genetic diseases.
Gene sequencing will almost certainly become much more prevalent in the future. I think Illumina will remain the leader in the technology for a long time to come.
It's been more than a decade since this pharmacy giant was this cheap
Sean Williams (CVS Health): Pardon the total "homer" move, since it's a now a part of my own portfolio, but I don't see a better deal in the healthcare space than pharmacy giant CVS Health.
CVS Health began the year on a low note when it dramatically reduced its full-year profit guidance. The company blamed this weakness on rising generic-drug usage, lower insurer reimbursement rates, and higher integration costs associated with its Aetna acquisition. But as is often the case with brand-name companies that are valued at single-digit forward P/E ratios, the market looks to be overreacting.
CVS Health's first-quarter operating results told a far less worrisome story. Same-store sales rose by a better-than-expected 3.8%, with brand-name drug inflation, especially with regard to Medicare Part D, boosting results, and the company reaping the rewards of its first full quarter of the Aetna integration. Although combined expenses rose, cost synergies from its Aetna integration are expected to hit $750 million by 2020, according to company statements earlier this year.
The bigger story here is that CVS Health's acquisition of Aetna now gives it a way to boost organic sales growth, as well as keep tens of millions of members within its pharmacy-benefit and consumer retail network. The Aetna deal may seem pricey on the surface, but if CVS Health can push consumer loyalty to new heights as a result of this merger, then the long-term rewards will dwarf any near-term costs.
This is a good time to mention that I also have little concern about drug-price reform on Capitol Hill. Neither political party can agree what the best course of action is, and it's been this way for more than a decade. While always a hot-button issue, branded-drug pricing has very little chance of facing serious reform anytime soon, which is a positive for the brand-name prescription medicines CVS Is filling.
Following the company's latest update, which included an increase in full-year EPS guidance to a range of $6.75 to $6.90 (up from $6.68 to $6.88), and a reaffirmation of $9.8 billion to $10.3 billion in full-year cash flow from operations, CVS is now valued at less than eight times 2019 EPS, and less than seven times full-year operating cash flow. Historically, that's very inexpensive, and all the more reason for patient investors to pick up a goliath in the pharmacy industry on the cheap.
