Themes: Healthcare, Drug Companies, Defensives
It doesn’t matter how uncertain the outlook for the global economy is, some things will always be in demand. We call these the ‘essentials of life’. Food, energy and health are good examples.
We’ve looked at food in a previous issue of The Right Side. Today, I’d like to focus on how to profit from another of life’s essentials: health.
You have three main investment options to consider in health – patented pharmaceutical companies, generic drug companies and what I call the ‘specialists’.
The patented pharmaceutical companies have been sound investments in the past. They’ve often been good defensive investments in downturns. However, when you look at the performance of the pharmaceutical & biotechnology sector over the last five years, you can see that there has been little share price growth.
As the chart below shows, the FTSE has increased only a few percent over five years. But the pharmaceutical sector has only done about 5% better than this.
There’s a simple reason these shares have stalled. Investors are concerned about the patents on these companies’ ‘blockbuster’ drugs expiring. That creates a big hole in earnings. And it’s proving to be increasingly difficult to come up with new drugs to replace these moneyspinners.
So where should you look for the best way to play the health theme?
Well, some of the larger generic drug companies provide a better alternative. That’s because the appeal of generic drugs increases as health care budgets come under growing pressure and generic companies successfully challenge some established patents. In particular, you should look at companies that have a successful track record of challenging existing patents and can offer their own patented pharmaceuticals for some of the less common diseases. We looked at some ideas in The Right Side of 11 June.
The best way to play the health theme
But there’s a far more exciting way to play this. I’m talking about smaller companies that have a strong specialist franchise. Specifically, we’re looking at things like diagnostics, drug delivery or treatments for niche diseases.
The kind of small, specialist company to look for needs to meet four conditions if it is to maximise its chances of success. Firstly, it needs to avoid direct competition with the large global pharmaceutical and health companies and, preferably, use them as customers.
Secondly, it needs to spread its risks. It should do this both geographically (by a presence in several countries) and by customer so it is not too dependent on just a couple of very large customers.
Thirdly, it needs to be very good in its niche so it is recognised as a world leader. Lastly, it needs to be financially strong, not just to survive in uncertain times but to give customers confidence to put their trust in it.
You can use these four criteria to help find the most promising investments in this area. The last three criteria are fairly straightforward but the first needs a little more explanation.
These small “niche” health companies need to avoid direct competition with the major pharmaceutical and health companies. One way they can do this is by concentrating on niche products which need significant R&D and technical expertise. By niche products we mean those with sales below the interest horizon of the majors. Several products of this type can still provide a really worthwhile business for a company, even one in the FTSE 250.
It’s even better if the large company becomes a customer. This can occur when the specialist company develops a new drug delivery technique. Or a large pharmaceutical company might fund a small biotechnology company to complete phase II and III clinical trials on a potential new drug. In both cases the small company would receive milestone payments for completing each phase. It will also receive royalties on sales which will be handled by the major company’s marketing teams.
Seven ‘specialists’ that are on my watch list
There are many specialist companies in the UK. Some that are on my watch list are Abcam (ticker: ABC) (a specialist in supply of quality antibodies), Advanced Medical Solutions(ticker: AMS) (a specialist in wound care), Corin (ticker: CRG) (for artificial joints), Dechra(ticker: DPH) (veterinary products), Deltex Medical(ticker: DEMG) (medical monitors), Immunodiagnostic Systems (ticker: IDH) (automated diagnostic tests of the more complex kind) and IS Pharma (ticker: ISPH) (speciality pharmaceuticals).
These are companies we’ll be looking at in more detail. The trick is to assess how well these and other similar companies match up against our four criteria explained above. Then we’d need to consider each company’s valuation and prospects before making a decision about whether or not to invest.
People will always be prepared to pay for the ‘essentials of life’. That’s why it’s such an important investment theme. The big question for us as investors is how to choose those aspects that are likely to yield good returns. The best approach – in both the food and health sectors – is not always the most obvious one.
Good investing,
Dr Michael Tubbs
For The Right Side
Editor’s note: Dr Michael Tubbs writes Research Investments which recommends companies with strong R&D investment into new products and services. Mike’s new report focuses on one aspect of this ‘essentials of life’ theme – and reveals a specific way you can play it. Discover the “forgotten commodity” here.
Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Seek independent financial advice if necessary.
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