Friday, December 14, 2007

2 New Positions in the Healthcare Field


Since I am mandated to have long positions, I am trying to expand out to some other areas - and am looking for things that will do ok in a more conservative environment. One could use an Altria (MO), Procter & Gamble (PG), etc. I still want some growth so I am going to move some exposure to the healthcare field. While these companies will never have rocket moves upward, since I am down to nearly 60% long exposure I need to get that up one way or the other.

One company I really like is Gilead Sciences (GILD) but this is a relatively highly valued biotech which still has some risks to it, it is currently at $46; if it drops to $44 or so, near its 50 day moving average I would probably be more interested. While $2 means nothing for a solar stock, an agriculture stock or a infrastructure stock, with more conservative companies, your entry point means a lot. As a rule I don't really play in the biotech field because many of these stocks are like gambling in Vegas - if a drug gets an approval, the stock shoots up 40%, if not it drops 50%. Not my type of thing. But Gilead has quite the pipeline, and track record and multiple drugs. However, even these "up and coming biotechs" you need to watch very closely - a peer in this area is Celgene (CELG), which not even 6 months ago was considered as promising as Gilead but whose stock has imploded. Hence, why I find this sector VERY difficult to invest in.

So instead of areas that are so dependent on FDA approval I like to invest in areas that are affiliated in the sector but not dependent on ABC drug passing phase 2 trials...

One area are the labs that the biotech and big pharma outsource some of their research work to - I have a Chinese version of this in WuXi PharmaTech (WX), but the American counterparts are doing very well. In fact a company such as Charles River Labratories (CRL) actually put out lowered (slightly) guidance for 2007 and weaker than expected 2008 guidance yesterday... and the stock is up today right to where it was before this news came out. That shows you the 'flight to safety'. There are about 4-5 stocks in this sector I am still sorting through - they have all made huge runs (for them) but despite high valuations investors keep fleeing to the safety (no recession will stop them), of this sector.

Two stocks in the pharmacy benefit management area (and are defensive) are MedcoHealth Solutions (MHS) and Express Scripts (ESRX). These stocks will do well through thick and thin, although not generally that exciting - essentially they help manage the process of delivering drugs to Americans - simple enough. Express Scripts actually generally has a higher beta (swings up and down more rapidly) but in this case I am going to buy MedcoHealth Solutions for the fund since it is closer to a support line (20 day moving average of $98.50) - and I don't see a need to buy both, and maybe Express Scripts runs up more in the near term, but I don't really want to add 2 "sort of boring" names doing the exact same thing to the portfolio.

Last, is an interesting company named Illumina (ILMN), which is one of a very small handful of companies working in the mapping of DNA - the Wall Street Journal had an interesting story on this group back in early October [DNA Decoding Maps Mainstream Future]. Interestingly, the big dog in the sector, Affymetrix (AFFX) is name near and dear to those from the late 90s - it was a market darling of the era. The 2 companies are in fact engaged in a nasty patent battle. Now again, for those used to investing in a fertilizer stock or solar stock this will be a boring name; but its exposure to the healthcare field without dealing with drug approvals and the risk to your stock imploding overnight.

Motely Fool had a quick story about Illumina's last earnings report here:

  • The problem with a company's stock going up 45% since the beginning of the year is that its employees tend to cash in their stock options. Illumina (Nasdaq: ILMN) faced that problem in the third quarter as its bottom line was eroded by $8.7 million in non-cash stock compensation.
  • The company experienced a stellar 82% year-over-year increase in revenue, but gross margins excluding non-cash charges slipped a whopping 700 basis points from the year-ago quarter to 63.1%, cutting into the bottom-line growth.
  • The change in gross margin was mostly due to the 206% year-over-year growth in sales of lower-margin instruments, including the new Genome Analyzer. Half of the 100 Analyzers that Illumina has so far sold were sold outside genome centers, and that bodes well for continued growth of instrument sales since there aren't that many large genome centers in the world. The placement of all those extra machines should drive sales of higher-margin consumable products used by the machines in the years to come.
  • Illumina doesn't expect this quarter to be a fluke. The company guided for about 5% sequential increase for fourth-quarter revenues, even in the face of holiday slowdowns in laboratories. Illumina needs to sustain that growth into 2008 if it wants to maintain the lofty valuation that investors have bestowed upon it.

Illumina is not cheap... on $1.20 estimate for 2008 it is trading at 47x '08 estimates, but with long term growth rates around 30% and a 'wide moat' (very high barriers to entry), it will be hard to enter this area in a cheap way. Affymetrix, which is growing slower, and has been stumbling around all year in execution has the same valuation at this time.

Technically after a large spike in late November, Illumina has pulled back from near $59 to it's 50 day moving average in the lower $55s. So I am buying here. The stock will either bounce or break through this support level. If it breaks through I will quickly reduce exposure and wait for a better entry point. This is essentially the tact I take with stocks trading near major support levels - the dangers (always) in using this type of strategy is stocks that 'pull back' to a support level will fall right through - so when this happens you have cut back or close out the position. More times than not, quality companies that pull back to support will bounce and hence this provides a great entry point. But not always.

So MHS is more of the safety stock, and ILMN is more of the growth stock - both should diversify me away from the type of holdings I am heavily focused on.

I am starting $15K-$18K positions in each name; or 1.2-1.5% of the fund's holdings in each.

150 shares of MedcoHealth Solutions @ $101

325 shares of Illumina @ mid-upper $55s

On strength I will be willing to add to both; especially Illumina.

Long MedcoHealth Solutions, Illumina, WuXi PharmaTech in fund; no personal positions

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