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Europe Woes Not Fatal for Health-Care Firms

Jason Stipp

Jason Stipp: I'm Jason Stipp for Morningstar. As the markets have experienced some increased volatility over the last few weeks, we've been keeping an eye out for potential opportunities cropping up. One area where we have seen some opportunities is in health care.

Here with me to talk about what he's seeing in health care, and how the issues in Europe might be affecting those valuation, is Damien Conover. He's a senior stock analyst, and the editor of Morningstar's Healthcare Observer newsletter. Thanks for being here, Damien.

Damien Conover: Thanks for having me, Jason.

Stipp: Certainly I think we've seen recently that a lot of things across the board have been hit by these European concerns. To what extent do you think there's some real fundamental issues with the health-care stocks that might have gone down in the last few weeks, related to Europe? Or is just a lot of health care going down with everything else that's been going down amid this volatility?

Conover: It's a great question, and it's an important question. I think what we're seeing is a lot of the fundamentals for these firms being very strong still. So the pressure that's going on in Europe is really causing stock prices to go down where it really is not warranted.

For example, Greece by itself is a very, very small market for most health-care companies, for pharmaceutical firms; it's 1% or less. So it's a very, very small fraction. I think what we're seeing there is potentially fear from investors that what's happening in Greece might spread to other countries.

Stipp: Europe as a market overall, if there is a general fear about slowdowns in Europe, about austerity measures in Europe, and maybe government reimbursements perhaps in some of those countries. To what extent if it really got bad in Europe might this affect some of the pharmaceutical companies, or other health-care companies that have business there?

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Conover: In general the European markets are about 30% of health-care revenues. Certain firms more, certain firms less. Pharmaceutical firms around 30%.

What we've seen in the past, Europe has never been a good environment for pricing. Meaning in the United States you can have very strong pricing power. Drugs in Europe, you tend to have to face quite a bit of a discount to the U.S. prices.

And as these countries are facing problems with their deficits and they're looking to cut costs, I think pharmaceutical firms will have to pay a little bit of the brunt of that cost reduction.

So I think that they will be potentially hit, but we have to keep it in context. This has never been a very friendly environment to start with.

Stipp: Now moving a little bit to companies that are based in Europe, health-care companies, are they likely to have more business in the European countries, and should we think about them differently, perhaps, than pharmaceutical companies based in the U.S.?

Conover: Potentially. If we take a look at some of the big pharmaceutical firms like Sanofi, if we like at Novartis, Astra, GlaxoSmithKline, all these firms tend to have a little bit more exposure to the European markets. But in general they're very well diversified across the globe.

So as these companies have pulled back a little bit more than their counterparts of the U.S. pharmaceutical firms, we think that's a pretty good opportunity for a lot of those firms.

Stipp: Potentially even more of a discount for some of those firms. Sort of a Europe discount for the crisis.

Conover: Exactly. It's almost as though that since they are located there they should be taken down further because of the fear. But really that, to us, seems like a pretty good opportunity.

Stipp: OK. Moving to a more sector, or industry-specific concern. In health care we've seen some opportunity there for a while, even before a lot of these European issues hit. What do you think are some of the risks still out there, absent Europe, but from an industry-specific perspective, that you might want to have on your radar?

Conover: Yeah. I think the key risk for the pharmaceutical industry is really the patent cliff that most of the firms are approaching and the lack of productivity coming out of the pharmaceutical firms' pipelines.

Historically, there's always been patent exposure, but usually the firms have been able to bring out the next generation of drugs. However, in this kind of post-Vioxx world where the FDA is very risk-conservative, it's been very hard for these new products to enter the market.

So we think there's a bit of a delay here before the pharmaceutical firms, who are just starting to adapt to this more conservative environment, will be able to bring out their new products. But eventually we think it will happen.

And we think coming out of the patent cliff these firms are very well positioned for growth, and so we're expecting quite a bit of multiple expansion, and some good earnings growth coming out of the patent cliff over the next two to three years.

Stipp: OK. Damien, looking down at the stock level then, do you have a couple of ideas where some these some of these issues might play out and become a good opportunity for investors?

Conover: Yeah, absolutely. The two names we like a lot are Abbott and Novartis. Just take those one at a time. Abbott is probably the only pharmaceutical firm that we would consider a true growth company. We see them as growing at double-digit growth over the next five years. No other pharmaceutical firm are we projecting that kind of bottom-line growth.

And so we think it's really one of the... If you wanted a growth company and you wanted to play the pharmaceutical industry, we would recommend Abbott.

Shifting to Novartis, Novartis is more of a core holding. We think it's got a great pipeline. Its growth isn't quite as robust as Abbott, but its valuation is much lower. So you've got a little bit of a value play, a little bit of a growth play. All in all, a well positioned company.

Stipp: Damien, thanks for the context and for the ideas today.

Conover: Great. Thanks a lot, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.