A selloff in Johnson & Johnson (JNJ) stock this month over potential legal damages from the alleged health risks of baby powder looks overdone. But the stock was expensive to start with. It has become only a so-so value at a time when prices are falling across health care, amid a market selloff and a court setback for Obamacare.
There are more deeply discounted health-care stocks for investors to consider, but first a look at J&J: It has fallen from $148 a share earlier this month to a recent $128, following media reports claiming it knew for years about potential asbestos in its talcum products. The company says its trademark Baby Powder is safe, and has been shown to be asbestos-free since tests for the carcinogen were created. This past week, J&J lost a bid to overturn a jury verdict that had awarded $4.69 billion to women who say its talc products gave them ovarian cancer. More cases are coming, implying a potential for vast financial liability.
Maybe not, however. Denial of a post-trial motion to set aside a verdict isn’t the same as losing an appeal. Filing such a motion was a formality before an appeal.
Danielle Antalffy, an analyst at investment bank Leerink, notes that among more than 40 talcum cases the company has fought so far, five are outstanding, and the rest have gone in J&J’s favor through wins, successful appeals, mistrials, or dismissals. The company has yet to lose a case on the matter or pay damages.
Assuming that Johnson & Johnson succeeds in appealing the $4.69 billion judgment, Antalffy estimates that the company’s total payouts on talc, including settlements, could fall in the $2 billion to $5 billion range. That compares with more than $50 billion in recently lost stock market value. And talcum products bring in less than 1% of company revenue. Antalffy calls the stock a Buy.
But with stocks so weak in recent months, investors can afford to be choosy. J&J has fallen from 17 times projected earnings for the next four quarters to just 15. But that still works out to a 4% premium to the S&P 500 (.SPX), whereas the shares have traded at a 2% discount, on average, over the past three years, according to FactSet. If that’s a buying opportunity, perhaps it’s not an urgent one.
A different, dubious court ruling might have created better deals for investors. On Dec. 14, a federal judge in Texas ruled that the Affordable Care Act, commonly called Obamacare, is unconstitutional. Hospital stocks plunged; some 20 million people have gained insurance coverage under Obamacare, and if the figure declines, hospitals could see more services go unpaid. But they could also collect higher payments from Medicare if cost caps under Obamacare are undone.
The judge in this case has a history of siding with Republican attorneys general on cases that appear ideologically motivated. UBS analyst Whit Mayo sees little likelihood that the decision sticks, and notes that public support for the law has been rising. Yet some hospital stocks have priced in a financial hit, and then some. By Mayo’s math, the recent decline in Universal Health Services (UHS) implies a 130% probability of Obamacare falling.
Based near Philadelphia, Universal owns hundreds of hospitals and mental-health facilities in 37 states, the United Kingdom, and the Virgin Islands, with a focus on markets with above-average population growth. Its shares go for just under 12 times next year’s projected earnings. Mayo’s price target of $156 on the stock implies 34% upside from recent levels.
Elsewhere in health care, drugmakers Pfizer (PFE) and GlaxoSmithKline (GSK) said last week they will form a joint venture for an eventual spinoff to sell over-the-counter products, including Advil pain pills and Flonase nasal spray for allergies. That will free both to focus on developing new prescription drugs, and the new company could have more leverage with retailers, such as CVS Health (CVS). Glaxo stock has returned 13%, versus a 6% loss for the S&P 500, since Barron’s recommended it a year ago. But earnings estimates for coming years have recently been falling—not exactly a buy signal.
Investors might want to focus instead on powerful long-term trends. One is the rise of health plans with high deductibles, where patients are responsible for, say, the first several thousand dollars of costs before coverage kicks in. In return, patients pay reduced premiums, while still benefiting from insurers’ price haggling with hospitals and druggists. They also get access to health savings accounts, in which they can stash funds pretax to cover those big deductibles and other costs.
Over 70% of Americans are covered by employer health plans. Employers like high-deductible plans, because when patients feel the financial pinch of health-care decisions, they tend to seek low-cost options. Over time, that could slow, or even reduce, health-care prices. A J.P. Morgan report last week estimates that 45% of people with workplace plans have opted for high-deductible versions. That suggests investors should favor companies providing low-cost, convenient health services directly to consumers. Three that J.P. Morgan likes are CVS Health, Laboratory Corp. of America Holdings (LH), and Teladoc Health (TDOC).
CVS has a drug plan manager in Caremark, a health insurer in Aetna, and a network of cheap walk-in clinics in its drug stores, giving it the ability to steer patients toward low-cost care. It trades at just nine times next year’s earnings forecast.
LabCorp faces pressure from payers like health plans, but it is also opening a network of sites within Walgreen stores. Patients can pop into these without appointments to leave specimens for tests requested by their doctors. LabCorp shares go for less than 12 times next year’s estimated earnings, versus closer to 13 times for rival Quest Diagnostics’ (DGX).
Teladoc partners with health plans to provide patients with cheap phone access to doctors who can prescribe treatment, including medication, for a variety of non-emergency ailments.
The company isn’t yet profitable, and its stock, at six times next year’s revenue, are hardly value-priced. But the shares have slid from $86 near the end of September to a recent $45, and Wall Street expects revenue to almost triple over four years, to $1.13 billion. If dial-a-doc service catches on with high-deductible patients, Teladoc could have a long runway for growth—or get snatched up by a bigger player.
There’s a blemish, though. A top executive resigned last week over allegations of a workplace affair and insider trading. The company says it hired a law firm to investigate the claims and found only violations of their workplace relations policy.
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