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Stock Strategist Industry Reports

Coronavirus Opportunity and Risk: Healthcare and Consumer Stocks

Our analysts discuss where they see value in their sectors today.

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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.

Coronavirus fears have pummeled U.S. stocks. The market lost more than 11% last week, and despite a notable comeback on Monday and a surprise 50-basis-point interest-rate cut on Tuesday, stocks haven’t yet found reason enough to stabilize.

In which sectors and among which stocks are coronavirus fears perhaps overdone? And as a result, where might investors find opportunity?

We asked our sector directors to share what impact the coronavirus outbreak may have on their particular pockets of the market and which stocks look like good opportunities after the sell-off.

Here’s what our healthcare and consumer specialists had to say. See what our technology, telecommunications and media, and financial services directors think, as well as thoughts from our industrials, energy, and basic materials teams.

Healthcare: Damien Conover
Several drug companies have less exposure to the impact of the coronavirus outbreak since their cash flows are largely driven by inelastic demands for important healthcare needs. A few of our most undervalued drug companies include Alexion Pharmaceuticals (ALXN), Intercept Pharmaceuticals (ICPT), and Roche (RHHBY).

Which undervalued healthcare companies could benefit from the outbreak? Generally speaking, the companies with experience with vaccines would be topped by Sanofi (SNY), GlaxoSmithKline (GSK), Pfizer (PFE), and Merck (MRK) (all of which are undervalued). As far as infectious disease expertise, the leader would be Gilead Sciences (GILD) (undervalued) among the large caps, but also other companies that have platforms that could help them with development in infectious disease among other areas. There is some overlap with vaccine makers, as Glaxo and Merck also make infectious disease treatments (HIV).

For our coverage, Gilead is the most advanced with remdesivir, a drug originally developed for Ebola that now has very preliminary positive data in COVID-19. (We should have more data by April from the trial in China; also, Gilead is starting two more trials of its own in March.) We have not incorporated potential sales into our model, as it’s not clear yet whether any of these therapies have real potential for sales. Outbreaks so far have dissipated before companies could complete development, and there could be generics that serve patients well, like the HIV and malaria drugs and flu antivirals being tested in China.

A vaccine would be a preferred product, but development would probably take longer than Gilead’s treatment, given significantly more safety hurdles; there is big difference between giving something to the broader healthy population versus a therapy given to patients who are already very sick and thereby willing to risk a side effect. Another vaccine program is with Clover/Glaxo, but that is still in the design stage. Sanofi aims to be ready to start a trial in a year, at the earliest. Johnson & Johnson (JNJ) (slightly undervalued) announced a vaccine first among the Big Pharmas.

Outside of the therapeutic area, healthcare technology companies could benefit. Teladoc Health (TDOC) (overvalued today) would likely benefit in an extended scare as its remote services would be an attractive option to prevent infection (this was even recommended by the Centers for Disease Control and Prevention last week). This initial pressing sales visit would also create an opportunity to cross-sell incremental services such as behavioral health and nutrition, as well as improve confidence in the services offered.

Strategist Karen Andersen and analyst Soo Romanoff contributed.

Consumer: Erin Lash
Travel and more discretionary-type purchases stand to be affected, whether because of the potential for supply chain constraints or a reduction or delay in consumer spending. Below, we list a few of the names we think are the most immune. Several of these were already undervalued before last week. Notably, even after last week’s pullback, several consumer product names are still fairly valued or trading in overvalued territory.

In the midst of expanding its education services offerings to complement its advantaged journals business, we contend that wide-moat John Wiley & Sons (JW.A) should be able to execute its diversification away from print publishing even as the burgeoning coronavirus pandemic unfolds. With its journals offerings sold to libraries via mostly digital subscriptions and to research authors for open access, and much of its growth linked to online degree programs that should not see a lasting negative impact from the outbreak (with potential upside if the virus leads more students to study virtually), we do not anticipate a large change in Wiley’s prospects, leaving the shares attractive at a roughly 23% discount to our $49.50 fair value estimate.

Given Kellogg’s (K) approximate 3.6% dividend yield and near 20% discount to our $78 fair value estimate, we think investors should consider adding shares of the wide-moat company to their basket. We still see the merits of Kellogg’s move away from direct-store distribution in favor of warehouse delivery in 2017, even though its top-line trajectory has been slower than peers’. However, we maintain that it has laid the groundwork to sustainably reignite sales. For one, we believe actions to expand its category exposure beyond cereal (with 50% of sales now from on-trend snacks versus 20% from North American cereal) will prop up its sales growth potential. Further, we like the changes to its pack formats to include more on-the-go offerings, which should also allow for increased penetration in alternative outlets. We think recent acquisitions (including smaller niche startups like RXBAR) afford the opportunity to grease the wheels of its own innovation cycle to more nimbly respond to ever-changing consumer trends as they relate to health and wellness and taste. Abandoning direct-store distribution positions Kellogg to elevate brand spending (rather than expend resources on its distribution footprint) to support its entrenched retail relationships--key in the intensely competitive landscape in which it plays, in our opinion. Based on his rhetoric since joining Kellogg and our assessment of the company’s current cost structure, we expect efficiencies will remain a pillar to fuel these investments under CEO Steve Cahillane’s leadership while also aiding profits.

We think investors underappreciate the growth potential of narrow-moat Hostess Brands (TWNK), leaving the shares trading about 28% below our $17.60 fair value estimate. Hostess has been steadily gaining share in the U.S. sweet baked goods category (from 16.3% in 2016 to 18.8% currently) and has experienced 5.2% average annual retail sales growth over the same period, despite flat category sales. This growth has been driven by Hostess’ unique access to the convenience, drug, and dollar store channels, enabled by its direct-to-warehouse distribution model, in place since 2013. Hostess is still in the early stages of expanding into dollar stores, reporting a 12.5% sales gain in 2019. In addition, through the 2018 Cloverhill acquisition, Hostess has gained access to the club channel, which we expect to buoy growth the next few years as the company expands distribution in this important market. The company is also expanding into tangential categories, such as breakfast pastries and cookies, with the recent acquisition of Voortman Cookies. We think these product line expansions can further monetize the strong Hostess brand, which commands impressive pricing power and is a pillar of our narrow moat rating. Revenue growth is not the only catalyst for the shares. We expect operating margins to increase from 2019’s 16.8% to 22.2% by 2021, as Hostess improves profitability of the acquired Cloverhill business and sells the lower-margin in-store bakery business. The net result is five-year average organic revenue growth of 3% and average earnings growth of 23%, which we think is currently underappreciated by investors.

We view Hanesbrands (HBI) as attractive, as it trades well below our fair value estimate. We think the market has been overly focused on short-term issues (inventory reductions at retail and debt) and overlooks longer-term opportunities that arise from the company’s intangible asset-sourced narrow moat. We believe Hanes owns some of the best-known brands in basic innerwear in the United States, which has enabled some of its products to outsell those of competitors by a wide margin. We also believe Hanes has been innovative, allowing it to maintain shelf space and good pricing. Further, we think Hanes’ Champion brand has benefited from the “athleisure” fashion trend and is being supported by new retail stores. Champion (excluding the C9 subbrand) produced sales of $1.9 billion in 2019, up from $1.4 billion in 2018. Champion is on pace to easily surpass Hanesbrands’ 2022 target of $2 billion in sales; the company has set a target of $3 billion over the long term. Hanesbrands has diversified its brand portfolio and expanded outside the U.S. It generated $2.5 billion in international revenue in 2019, up from less than $500 million in 2013. International is now Hanesbrands’ largest segment. The company is expanding its presence in online and activewear sales as well. These businesses have higher growth than traditional retail innerwear, and research suggests that brands are more important in these markets. We think the market fails to appreciate that Hanesbrands has significant potential for margin improvement. We forecast overall adjusted operating margins will gradually improve from less than 14% in 2019 to 15% in 2023 as the company works to extract inefficiencies from its operations and instills best practices in its recently acquired businesses. Further, although Hanesbrands has long-term debt of more than $3 billion, it is making substantial progress in debt reduction. Hanes did not repurchase any shares or increase its dividends in 2018 or 2019. However, the company lowered its debt/EBITDA to 3.3 times at the end of 2019 from 4 times at the end of 2018, which we believe will allow it to direct its robust free cash flow to equity (about $700 million in 2019) to shareholders. In 2020, we anticipate Hanes will return about 36% of earnings to shareholders through dividends and repurchase about $200 million.

Lastly, consumer strategist R.J. Hottovy says undervalued (AMZN) is his top pick for the current environment. “Obviously there will likely be some impact due to the coronavirus,” he says, “But its grocery sales are spiking right now, and the impact to Amazon Web Services should be minimal. There will likely be some supply chain issues for third-party sellers, but the facilities manufacturing their own hardware are still operational, from what I understand.”

Strategist R.J. Hottovy and analysts Zain Akbari, Rebecca Scheuneman, and David Swartz contributed.

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