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Healthcare Sector Adjusts to Pandemic's Pressures

And four companies we like right now.

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Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

Damien Conover: In looking at the healthcare sector, we've seen some strong performance over the last 12 months. The sector as a whole is up almost 25% over the last 12 months, and that's largely in line with the overall market performance. 

Now, I think there's a few things that are important to point out about the healthcare performance. The underlying fundamentals are largely solid, and with the U.S. elections coming up, healthcare is going to be a very important area of focus with the political rhetoric. Although we don't expect any major changes to the healthcare sector because of policy changes, a lot of this has to do with both of the leading presidential candidates looking at healthcare in more-moderate levels of reform.

From a valuation perspective, when we take a step back and look at where healthcare is now, overall, we see the sector as slightly overvalued. Now, part of that's due to the recent runup that it's had, and we only see a few good buys within the space. 

Within the industry as well as healthcare sector, the two areas we're advocating people to take a look at are the drug industry and the managed-care organization space. These are two industries that, in our view, look undervalued. Now, some of this has to do with the potential changes in healthcare policy. Now, again, we don't expect major radical changes, but the market is implying a lot of potential pressure for both of these groups. On the drug side, there's a lot of heated rhetoric around bringing down drug prices. But from our view, we expect more-moderate changes with whoever gets into the presidential office, and whichever group, Democrat or Republican, takes over the Congress. Similarly, from the managed-care perspective, we don't expect "Medicare for All" to be rolled out. We expect more-modest changes, even if Democrats roll in to both the Congress and the presidential office.

From a fundamental standpoint, we think the healthcare sector is adapting well to the coronavirus and the related economic pressures. One of the things that is important to note with the coronavirus is it's really having a more modest impact on the drug stocks and the managed-care industry. Drugs are being prioritized, and interestingly, a lot of the more expensive surgeries are being put off, and that's actually beneficial for managed-care organizations, so they don't have to spend as much to reimburse those expensive surgeries.

Outside of those industries, a lot of the other groups within healthcare are facing some pressure. So, we think about the dental group, and we think about some of the life-sciences groups--a lot of those purchases and utilization rates have dropped down during sort of the peak of the coronavirus back in the April-May time period, but subsequently are rebounding very significantly.

Additionally, from the economic impact of the coronavirus, because healthcare tends to be prioritized, this is an area where we think will bode well despite some of the increased economic pressures that are likely still to come. In looking at the coronavirus over the next 12 months, we really see the potential cure coming from the healthcare landscape. The vaccines in development right now from some of the leading firms-- Pfizer, AstraZeneca (AZN), Moderna (MRNA)--these are all vaccines that potentially could have pivotal data by the end of the year. Now, we think this is important from a societal standpoint, but we don't think this will be a major driver of cash flows because a lot of these vaccines will be priced at a not-for-profit basis. Nevertheless, the goodwill that these companies could engender should potentially help them in defending against the pricing power of other drugs against potential new policy measures.

Overall, when we look at the healthcare space from a stock perspective, a couple of names that we think are most undervalued that we'd highlight within the managed-care organization: We really like Anthem (ANTM) and CVS (CVS)--again, well-positioned entities that shouldn't face a lot of pressure from new policies. On the drug side, Pfizer (PFE) and Biomarin (BMRN) are two names we really think are well-positioned, with underappreciated pipelines in areas of unmet medical need, which, regardless of new potential political policies, should still have strong pricing power that we think is underappreciated by the market.

Damien Conover does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.