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What the New Congress Means for Healthcare Stocks

Damien Conover expects to see fewer major changes to U.S. healthcare policy, and he offers some picks for investors.

Damien Conover: The U.S. election is recently completed, and the outcome has left us with a split Congress which has implications for the healthcare sector that I think investors need to be aware of.

When we take a step back, we think the split Congress will likely mean less radical change to U.S. healthcare policies. What that means is, we'll likely see smaller implementation of past laws that have already been voted on but not yet enacted. We want to walk through some of those, and then, also, what is likely to happen from the rhetoric standpoint.

We think the most important upcoming change is an increase into the Donut Hole Discount. What that means is, when patients get to a certain point in spending, their drug prices are going to change by the amount of the discount offered by the drug companies. The discount historically had been at about 50%, that's going up to 70%. That's going to hurt the drug firms, but let's keep the magnitude in mind here. This is probably about 1% earnings hit to the large-cap pharmaceutical and large-cap biotechnology firms. This is something we think is manageable through some price increases elsewhere within the drug distribution space as well as through some cost cutting.

The second thing that's very likely to happen is increased pricing negotiation for Part B drugs. These are drugs that are administered in the hospital. This is something we think a split Congress can get behind and likely pass, so that will likely cause some more pricing headwinds for the drug and biotechnology firms, probably in the neighborhood of about a 2% hit. 

In this backdrop of increasing pricing pressure, we still think the drug space is an interesting place to invest in, because we think those costs on the drug firms are manageable. We think that the firms will be able to, again, cut costs or increase prices elsewhere to get around those increasing pricing concerns.

One thing that we think is also important is the increased rhetoric that is very likely to come out of Congress and the president's office, and that is, lowering U.S. drug prices that are something compatible to what we see in other developed markets. We think this is unlikely to actually come through. We think it's going to be more rhetoric. The reason why is, there's a high degree of complexity around bringing U.S. drug prices down to developed market prices outside the U.S., because of access issues outside the U.S. versus the U.S. That leads us to believe that it's very likely going to continue to be spoken about but not enacted.

Within this landscape of a new Congress and what we are anticipating not being major change in the political landscape, we're highlighting a couple of ideas for investors. First off is underappreciated innovation. Roche is a name we really like; very strong position in immuno-oncology as well as several other therapeutic areas we think the market is underappreciating. Also, any company that can do well in creating more value for anything within the healthcare landscape. Medtronic is a name that we think is underappreciated in this respect. They are bringing out a lot of products that have the ability to save costs for hospitals. Also, certain companies just have certain special situations that we think are well-positioned for investors. Bayer, we think there's a huge overreaction in some litigation that its crop science business is facing. We think that's an opportunity for investors.

And then, lastly, on the M&A front. We think that will continue to happen. We think it's important for investors to be aware of potential opportunities of targets that could be acquired. Biomarin, we think, is at the top of this list. The reason why is this firm is focused on rare disease drugs, and this is an area where a lot of the large-cap pharmaceutical and biotechnology firms want to gain more traction, and we think an easy entry point is by acquiring Biomarin.

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