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Quarter-End Insights

Healthcare: Valuations Improve as Concerns Over Drug Pricing Pressures Begin to Abate

Innovation, clearing regulatory picture, corporate restructurings, and capital redeployment should continue for healthcare stocks in the fourth quarter.

Damien Conover
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  • Overall, healthcare valuations have slightly risen to a price/fair value of 1.07, up from 0.98 at the end of the second quarter and 1.04 at the start of the year, but the differences in industry valuations continue to suggest drug, biotech, and drug supply chain industries are the most undervalued areas. Within these industries, our top picks are  Cardinal Health (CAH),  McKesson (MCK), and  Roche Holding (RHHBY).
  • Innovative new drug launches combined with strong advancements in drug pipelines are supporting a steady growth outlook for the drug and biotech industries.
  • Concerns around U.S. governmental reforms addressing drug pricing appear to be easing on the valuations for drug manufacturers with the majority of reform concerns still surrounding potential changes to the drug supply chain.
  • Corporate restructuring and redeployment of capital represent key strategy decisions within the healthcare sector as noncore assets are increasingly divested and strong cash flows are supporting continued acquisitions both within the healthcare supply chain and within the drug and biotech industries.

Within the healthcare's largest industry of drug and biotech companies (by market capitalization), we expect the recent strong launches of innovative new drugs and pipeline advancements to reinforce the economic moats in the industry and support steady growth. We expect several recently launched drugs to continue to gain market share and grow not dependent on pricing, but on strong efficacy data that will displace older drugs. In immuno oncology, several recently launched drugs exemplify this trend. The immuno oncology drugs offer some patients a near cure over older drugs that typically just delay progression of certain cancer types. In addition to tracking well with the initial indications, these immuno oncology drugs are also posting excellent data in new indications, setting up a strong outlook for future growth. Beyond immuno- oncology, advancements in other therapeutic areas, such as immunology and cardiology, are also supporting major innovative advancements that are driving strong sales growth.

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

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