The medical research service and biotech industry in China is growing rapidly, similar to the medical device space, with the players including domestic and multinational companies, at somewhere from 15% to 25% growth rates, depending on which subsector, says Ingrid Yin, a Managing Director and Senior Analyst for Oppenheimer &. Co. Inc.
“Compared with the U.S. biotech industry, China biotech is in the early stage of development. There are some companies that are making things along the lines of biosimilars,” she said. “China’s EPO market is much smaller than the U.S., which is billions of dollars in sales. In China, it’s still only hundreds of millions of dollars, though China has a much bigger population.”
Yin describes 3SBio Inc. (SSRX) as a dominant leader in China’s EPO market. She says as a domestic player, 3SBio has certain advantages in the marketplace due to its long-time presence. Yin also says the company is undervalued although it is growing above 20% revenuewise and has delivered strong quarterly performances.
“They know a lot of nephrologists and oncologists in the top hospitals offering dialysis services. They compete both on price and also entrenched relationships. They were one of the pioneering companies that educated doctors how to use EPO in both the anemia and the oncology setting,” she said. “3SBio is an entrenched player in that area. I mean, they still own more than 40% of the market share.”
Companies in the diagnostics space, in general, and those names in the life sciences tools space that are moving to the diagnostic side should have more pricing power and long-term growth potential with less exposure to some of the volatility currently in the market, says Vamil Divan, M.D., a Vice President and Senior Analyst at Credit Suisse Group.
“I think I definitely have a little bit more positive sentiment on the diagnostic companies, because I see what they’re offering. Even the tools companies, as I mentioned, some of them are trying to get their stuff to be a little bit more clinically relevant,” he said. “I think there, if you are providing innovation and providing real value, you can move yourself away from some of these headwinds on the macroeconomy and government funding of research, by providing tools that might help diagnosis or better treat people with diseases.”
Divan highlights Cepheid (CPHD), which he says is more of a pure diagnostics play. He says Cepheid is not specifically a tools provider, however the company offers the best-in-class platform to do molecular diagnostic testing. CPHD is predominantly focused right now on testing for infectious diseases, specifically those that are acquired in the hospital setting, but it is expanding to additional tests in virology, oncology and women’s health.
“We still see a lot of room for this technology to gain traction, not just in the larger hospitals in the U.S., where they’ve been focused, but also in small and medium hospitals in the U.S. and internationally. Only about 30% of their revenues are international, and I think there is lot of room for them to grow there,” he said.
Manufacturers in the solar arena that do not produce a commodity product, such as the wafers, cells or modules, offer pure-play opportunities for investors versus companies that make these products, where the oversupply and the margin pressures are in the sector, says Pavel Molchanov, an Analyst at Raymond James & Associates, Inc.
“The reality that the solar manufacturing arena is facing structural and severe oversupply has actually not changed at all in the last six to 12 months. Whether it got worse or is about the same, I suppose, is debatable, but it remains an extremely tough market,” he said.
Molchanov favors Enphase Energy, Inc. (ENPH), a leading provider of microinverters, a cutting-edge product with little competition right now and for the foreseeable future. He says Enphase is the world’s only major producer of microinverters, and that’s why in the context of declining industry margins and flat-to-down revenue, Enphase in 2012 is poised to grow top line by about 60%, and should improve its gross margin by several percentage points.
“It’s not currently a profitable company, but we think Enphase will turn cash flow positive about a year from now. Last year’s revenue was $150 million. This year, we are projecting more than $220 million. So it is a well-established company in the solar inverter arena that is growing and taking market share despite a difficult market environment,” Molchanov said.
The general thesis across the life sciences and diagnostic tools segments has been to find companies with better visibility than the group, or compelling new product stories that can help them to have some predictability in their earnings, which has led to a focus on the the larger companies, says Amit Bhalla, a Director at Citi Investment Research & Analysis.
“They have broader geographic and product diversification than some of smaller companies in the space. It is a slightly a more cautious approach in picking stocks in the group, but if you take each one of the companies, they do have some pretty compelling reasons to own them,” he said.
Bhalla likes Life Technologies Corporation (LIFE) and has a “buy” rating on the company. He believes Life Technologies has one of the most exciting new product launches in the sequencing space, the Ion Proton System, which is set to launch in September of this year.
“The company has already taken 100 orders for the system. There are already 1,000 Ion PGM systems in place, and we think these next-generation benchtop sequencing systems are going to change the landscape in sequencing in both price as well as throughput,” Bhalla said.
Although the rapid price inflation of corn, wheat and soy due to recent domestic drought conditions and record-high profits for farmers are translating into very good demand for irrigation equipment through the second half of 2012, C. Schon Williams, Vice President at BB&T Capital Markets, warns the continuous rise is not sustainable forever.
“There is a tipping point, where if we start to see too much of the crop actually destroyed, that could leave farmers at a point where they actually have no crops to produce whatsoever, and at that point, they become totally reliant on government insurance to backstop them. And in that environment, economically, they are probably OK. They will be made partially whole by the insurance, but it could actually have a negative effect on demand,” Williams said.
Williams has a “buy” rating on Valmont Industries (VMI), an irrigation equipment company with an electrical transmission component to the business. VMI is a bellwether in the irrigation equipment space and has already seen some upside due to its exposure to the agricultural spikes, and the company’s transmission business is also seeing positive catalysts.
“Valmont has seen very good order activity on the transmission side and the pricing dynamic has improved significantly as well because there is still fairly limited capacity within the industry, Williams said. “At the same time that you’ve seen the order books increase, the pricing environment has improved dramatically as well. So in my mind, a name like Valmont has additional catalysts going forward that would benefit earnings down the road.”
Property owners in the medical real estate sector are benefiting from a low cost of capital, increased access to capital and a still-fragmented industry’s growth opportunities, says Daniel Bernstein, CFA, an Analyst at Stifel, Nicolaus & Co., Inc., however, he has been cautious on some of the valuations in the sector due to the macroeconomic environment.
“I think with the cost of capital decreasing, mainly because of the decrease in the 10-year Treasury, particularly for large portfolios of high-quality senior housing and medical office, we are continuing to see and expect further cap rate compression, perhaps 25 to 50 basis points of compression from the acquisition rates that we saw some of the large caps make last year,” he said. “The increasing real estate value is, I think, an indicator of potential for increased stock prices in the health care REIT sector.”
Bernstein has Sabra Health Care REIT, Inc. (SBRA) as his top pick on the health care REIT side. He says Sabra was created from the split of the property from the operator at Sun Healthcare in late 2010, and he likes SBRA despite some risk affiliated with the company due to about 70% of the NOI is with one tenant, currently Sun Healthcare.
“But as Sabra diversifies its tenant mix away from Sun, and also potentially later on, maybe a year or two out, begins to diversify away from postacute/skilled nursing and into senior housing, as their cost of capital comes down, we think there’s potential for Sabra’s multiple to increase from where it is today,” Bernstein said.
The orthopedic utilization market is showing improved growth worldwide and certainly in the U.S., and names most levered to the recovery in this segment of medical devices are favored, says Matt Miksic, a Managing Director and Senior Research Analyst at Piper Jaffray & Co.
“We’ve been making a call, since January, across a couple of segments of our universe, that surgical trends and procedure trends are improving in the U.S., after approximately four years of going sideways or declining due primarily to the U.S. recession. That call crosses over probably half a dozen stocks in orthopedics, sports medicine and spine,” he said.
Miksic recommends Zimmer Holdings, Inc. (ZMH), an orthopedics company. He says, in terms of stock performance, the company is set to benefit proportionally as its market improves, and Zimmer came in roughly in line with earnings expectations.
“The names most levered to the recovery in orthopedics utilization are Zimmer on the large-cap side,” Miksic said. “Zimmer is 85% exposed to hips and knees, so when that moves, they have an awful lot of leverage to that market.”
Fundamental trends are solid for health care REITs as they continue to have an advantage in terms of cost of capital over many of their private-sector peers, their balance sheets are in good shape, and they’re able to benefit from opportunities across various health care sectors, such as senior housing, medical office buildings and life sciences, says James Milam, an Associate Director at Sandler O’Neill + Partners, L.P.
“We have seen transaction pricing compress over the last 12 to 18 months, so it’s maybe been a little bit harder for them to win deals than when they were really dominant in 2011, but I still think the public capital markets are supportive of the acquisitions that these companies are doing,” he said.
Milam says LTC Properties Inc. (LTC) is his top pick in the health care REIT sector. It’s a smaller company that’s trading at somewhat of a discount to the group, which he believes is partly related to size, however he says LTC is disciplined in terms of how it executes its growth strategy.
“They have a phenomenal balance sheet with very little leverage. They’re essentially acquiring skilled nursing facilities, and also doing some standalone memory care development, which they can fund with low-cost debt, probably around 5%, and investment yields are around 9% or 10% for them. So that’s a story we continue to like,” Milam said.
Investors should look to companies with quality assets as the provider side of the medical real estate sector continues to face the major trends of cost cutting, reimbursement and consolidation, in addition to the uncertain economic and regulatory environment, says Thomas Gallucci, a Managing Director and Senior Analyst at Lazard Capital Markets.
“The third thing that I would mention over and above cost cutting and the changing reimbursement environment would be consolidation. In a difficult macro environment, in an environment where reimbursement systems may be evolving, I think it increasingly leaves the less sophisticated and less well-capitalized hospitals in a weaker position,” he said.
Gallucci favors HCA Holdings (HCA) because it is a diverse company with a variety of business segments, although it is still predominantly an acute care company. He says HCA owns an array of the highest-quality assets in the industry and are in strong spots geographically.
“We also believe that they have a very sophisticated management team. So I tend to gravitate toward HCA because I believe in a fundamentally more difficult operating environment those higher-quality assets ultimately lend better visibility on solid results in the long run,” Gallucci said.
The orthopedic space within the medical device sector is attracting attention from investors as it begins to show some signs of recovery in its stocks and markets, says Joanne K. Wuensch, a Research Analyst at BMO Capital Markets Corp.
“You’re probably getting some demographic play in there as aging Baby Boomers are crossing over age 65,” she said. “You’re probably starting to get a little bit of play in there from people who, several years ago, put off surgeries and are now starting to come back into the fold.”
Wuensch points to Zimmer Holdings, Inc., (ZMH), a smaller medtech company, due to its decent first-quarter performance. She says she has started to see better knee numbers for the company in the marketplace.
“We’re spending time right now on Zimmer, and if the orthopedic market does truly percolate back, they have almost 80% of their revenues dedicated to hips and knees, and they will benefit. At 11 times 2013 earnings, that seems to be an attractive valuation,” Wuensch said.
