Is Pharma Still Defensive?

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. How have health-care stocks held up to the recent market turmoil? I'm here today with Damien Conover. He is associate director of equity research at Morningstar, and we'll take a closer look at the stocks.

Damien, thanks for joining me today.

Damien Conover: Thanks for having me, Jeremy.

Glaser: So let's take a look at the health-care stocks as a whole, but in particular Big Pharma. How have they really held up through this, just wild swings that we've been seeing in the market in the last few days?

Conover: Yeah, it's a good question. I think in general, most of the stocks are down, so in this falling market even health care, which tends to be a little bit more defensive, has come down with the market, not to the same extent as some of the other sectors, but overall this market has been so harsh across the board, even health-care names are coming down.

Glaser: So it's doing maybe a little bit better than say, financials or basic materials, but still getting hurt. Do you think this is just being driven by the fears of the economic slowdown, or did we see something during the pharma earnings season that is getting investors little bit concerned?

Conover: I think in generally, earnings came in quite good, and we saw lot of actually, increases to guidance for the full year, so I really think from a company-specific standpoint for big pharmaceutical firms, earnings are tracking very well and actually potentially even improving. So I really think it's the overall market pullback that is really causing fear across the entire space, including health care and including Big Pharma, that has caused those stocks to come down a little bit.

Glaser: Another area where I think there could be a fair amount of investor fear is what's going to happen with that government's involvement in health-care in particular with potential cuts to Medicare or Medicaid that may be discussed from the so-called, super committee that needs to take a look for deficit reduction. What do you think the impact of that's going to be on the pharma space?

Conover: I think that's a really good point. I think right now it's a little bit uncertain to exactly what's going to happen, but what we think likely is that there could be some further pressure on some of the pricing for Medicare Part D drugs. I think most likely is that there is this case where if an elderly person is dual-eligible for both Medicare and Medicaid, right now they get reimbursed at Medicare rates, which are more profitable for pharmaceutical firms. I think some of those folks could start to get reimbursed in Medicaid rates; that's going to be a headwind for the pharmaceutical group, I think that's probably the most likely headwind for the big pharmaceutical companies, but overall I think there is that uncertainty that's weighing on that group. And if there is one thing investors dislike more than negative news, it's uncertainty. So that uncertainty is probably going to hang over the group, at least for a couple of months until we figure out exactly the direction that Washington is going to go.

Glaser: So we have these open questions about reimbursement rates, we see the stocks falling you know at a fairly good rate and you know even in the last crisis 2008, the health-care stocks and pharma stocks in particular fell, I think more than a lot of people expected. Is this still a defensive sector? Is this really an area where investor is looking for somewhat of a countercyclical place? Is this still place to look?

Conover: That's a great question. I think it is. I think it is a defensive space. I think the past recession that we had was so severe that all the job cuts actually really cut into people's insurance, so it really did hurt the health-care space overall. But, even we look at or we look at health-care spending, most of that is pretty inelastic; many folks are going to have to spend on these products. So when you take a look at the cuts that consumers are going to make, they are going to cut a lot of other things before they cut their health-care expenditures. So I think we can really look at this space as still defensive and a good place to go if you are uncertain about the trajectory of the overall economy.

Glaser: Looking at some individual names, what do you think looks attractively priced after the sell-off.

Conover: I think there is a lot of names right now that look attractive, it's interesting, I think this is a good buying opportunity in Big Pharma. There are a couple of names that we like a lot. Abbott Labs is one that we like a lot; we think that's a very strong growth story. We're projecting about 9% growth annually during the next five years for Abbott, which is kind of unheard of in the pharmaceutical area because of the patent cliff most of the other firms are facing. So Abbott's name we like a lot.

Another name we like a lot is Pfizer. Pfizer doesn't have the growth potential that Abbott has but from a valuation perspective, Pfizer looks very undervalued from our view.

Glaser: Damien, thanks much for your thoughts today.

Conover: Thanks for having me, Jeremy.

Glaser: For Morningstar, I am Jeremy Glaser.