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Stock Strategist

Democrat-Proof Health-Care Stocks

Despite changing political winds, we're still bullish on these five firms.

Several members of the incoming Democratic Congress have listed health-care reform as a top issue. Not surprisingly, the party's new position of power has struck fear into the hearts of many health-care investors; the Amex pharmaceutical and biotechnology indexes were down roughly 4% and 2%, respectively, over the two days following the election. With the Medicare Trust Fund poised for bankruptcy during baby boomer retirement, many Democrats are eager to give the government more control over the drug industry by facilitating direct negotiations over drug prices and a pathway for the approval of generic biologics. While some investors have clearly been discouraged by the prospect of more government control, we think there are several health-care stocks that are well-shielded from any potential Democrat-initiated legislation.

GlaxoSmithKline PLC  (GSK)
Business Risk: Average
Economic Moat: Wide
More than half of this U.K.-based firm's pharmaceutical sales occur outside the U.S., creating international exposure that buffers Glaxo from U.S. regulatory changes. Vaccine development, widely supported by Democrats, is an important part of Glaxo's product portfolio and strong pipeline. The firm's sizable consumer health-care business provides additional income diversification. From Heather Brilliant's  Analyst Report: "GlaxoSmithKline has amassed an impressive lineup of pharmaceutical offerings. While the firm has several blockbusters in its portfolio, its revenue comes from a wide variety of drugs, insulating it from the generic competition risks that most of its competitors face."

Novartis AG (NVS)
Business Risk: Below Average
Economic Moat: Wide
Novartis has a unique level of diversification that makes it one of our favorite large pharma stocks. In addition to its two largest divisions, pharmaceuticals and consumer health care, 16% of the company's 2006 sales have come from generics division Sandoz. Like Glaxo, international sales are a dominant part of the mix. From Heather Brilliant's  Analyst Report: "Its pharmaceutical business has the inside scoop on how to protect its patents from generic challengers, and Sandoz has exceptional manufacturing expertise in difficult-to-make drugs. Further, as growth slows in the branded drug market, Sandoz is well-positioned to benefit from the double-digit growth we expect in the generic drug industry."

MedImmune 
Business Risk: Above Average
Economic Moat: Narrow
While a Democratic Congress is generally perceived as a negative development for biotech as well as large pharma, MedImmune's story is slightly different. Its lead drug, Synagis, has already faced reimbursement pressures, and new data from an improved version of the antibody gives us more confidence in this company's power to prevent further reimbursement concerns. Although FluMist has yet to become a commercial success, Democrats support preventive medicines such as flu vaccines; a newer version of this inhaled vaccine appears to have several advantages over its predecessor and the more standard injected vaccine, which could allow MedImmune to tap into the pediatric and baby boomer markets. Finally, as I discuss in my  Analyst Report: "MedImmune has a strong track record in vaccine technologies; it receives royalties from Merck for technology used to create HPV vaccine Gardasil, as well as licensing fees for its reverse genetics technology, the standard for avian flu vaccine research."

Hospira 
Business Risk: Average
Economic Moat: Narrow
Generic drug stocks, on the other hand, are poised to benefit from increased government control of pricing and drug-related decision-making, and we like Hospira's focus on the generic injectables niche. As a spin-off from pharma and device giant  Abbott (ABT), Hospira retained a solid management team that is well-qualified to lead the company through regulatory changes. Finally, its new partnership with German generics firm Stada marks the start of efforts to pursue generic biologics--a pathway for such drugs already exists in Europe, and products could be approved as early as next year. While the timeline in the U.S. will be much longer, the Democrats are creating several possible bills that could accelerate these changes. From Brian Laegeler's  Analyst Report: "Hospira is a well-established hospital supply business with wide-moat potential....A particularly hard-to-make drug form, injectables remain one of the few havens from severe price competition in the generic market. Potential entrants face significant economic barriers as complex factories, specialized distribution, and innovative packaging are all necessary for success. This means fewer competitors and more stable pricing in a market where Hospira commands a 20% share."

Charles River Laboratories International (CRL)
Business Risk: Average
Economic Moat: Narrow 
While drugmakers and the FDA struggle to balance safety concerns with the high costs of lengthy clinical trials, preclinical and early-clinical development are becoming increasing important. Charles River shines in this niche. With the possibility of growing governmental safety oversight, drug companies are more motivated than ever to cut off the development of potentially toxic drugs as early in the process as possible. From Alex Morozov's  Analyst Report: "The firm's preclinical services are growing rapidly. Large drug developers do not consider these studies, particularly toxicology, to be a core competency and increasingly outsource them to contract research organizations. As one of the very few contract research organizations with expertise and infrastructure capable of addressing this growing demand, Charles River stands to benefit considerably from this trend."

With another two years of Republican leadership in the executive branch, we're not likely to see big health-care reforms passed in the next two years. But given the growth of our nation's health-care expenditures and this trend's key role in the agenda brought forward by the incoming speaker of the House Nancy Pelosi, we think investors would be smart to start thinking about how the health-care industry might evolve over the long term.

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