When investors think about healthcare stocks, growth is often the first word that pops into their minds. This happens with good reason, as health care issues are often quintessential growth stocks. By a growth stock, we mean the shares of a company with its earnings increasing at a higher rate than those of peers. In general, growth stock investors focus on the denominator in the price-to-earnings (P/E) ratio, looking for companies or industries where high earnings growth will propel stock prices upward. Such issues typically do not offer generous dividend yields, as company managements usually prefer to reinvest profits in the business in order to take advantage of high returns on capital and to support bottom-line growth, rather than distribute a significant portion of net income to shareholders in the form of dividends.
That said, there are healthcare companies that pay dividends, a number of which are quite generous. To find some of these issues, we screened the Drug, Medical Supply, Medical Services, Pharmacy Services, and Biotechnology Industries. First, we looked for companies with dividend yields above 1.0%, and then, to help ensure the dividends were sustainable, we limited the results to those firms with long-term debt as a percentage of total capital below 50%. The companies highlighted below also have favorable investment prospects, in our view.
Cardinal Health, Inc.
Cardinal Health, Inc.’s (CAH) Pharmaceutical unit (~75% of profit contribution) distributes branded and generic pharmaceuticals, over-the-counter healthcare products, and consumer goods to drug stores, mail order pharmacies, pharmacy departments of supermarkets, mass merchants, hospitals, surgery centers, and physician offices. In addition to distribution services, it helps pharmaceutical manufacturers with inventory management, data/reporting, and new product launch support. It nurtures these vendor relationships to streamline the purchasing process, which results in greater efficiency and lower costs for customers. The Medical unit (25%) distributes medical, surgical and laboratory products. It also manufactures, sources and develops its own line of single-use surgical drapes, gowns and apparel; exam and surgical gloves; and fluid suction and collection systems.
Year-over-year fiscal 2011(ended June 30th) earnings growth clocked in at 20%, but slowed to 6% in the first quarter of fiscal 2012. Nevertheless, analyst Joel Schwed remains upbeat about the company’s prospects this year. He looks for improved healthcare utilization rates, and recent profitability-enhancing acquisitions, to pave the way to higher profits. CAH completed three buyouts in the past 18 months, spending over $2.3 billion. They include Kinray (to increase nonbulk and generic exposure) and Yong Yu (for pharmaceutical distribution in China). China presents a very large revenue opportunity considering its tremendous healthcare industry growth rate, fragmented distribution network, and a government that’s committed to providing more efficient healthcare to its population. The launch of generic Lipitor (used for lowering blood cholesterol) should also benefit results.
Aside from margin-accretive acquisitions, profitability ought to be boosted by a more streamlined supply chain, initiatives to find an optimal product mix, and more appropriate pricing on products and services. Too, drug price inflation has been fairly mild of late. Higher raw materials costs will likely somewhat offset this, though.
Cardinal stock remains a fine risk-adjusted growth candidate, and the solid dividend payment (current yield is 2%) sweetens the pot. Indeed, annual dividend increases have become commonplace, and management has indicated that this will be a primary use of cash in the years ahead.
Medicis Pharmacutical Corporation
Medicis Pharmaceutical Corp. (MRX) offers 16 branded prescription and non-prescription products to treat dermatological conditions. The company executes a four-part growth strategy that includes: expanding sales of existing brands; launching new products from intensive R&D efforts; acquiring complementary products and businesses; and collaborating with other companies. Its products are sold primarily to wholesale pharmaceutical distributors. 2010 revenue breakdown: Acne and acne-related dermatological products: 69%; Non-acne dermatological products: 25%; Non-dermatological products (including contract revenues) 6%.
MRX shares have come under pressure over the past three months, partly due to concern that the blockbuster drug Solodyn has little room to grow. That product is the #1 dermatology medication by sales in the world, and closed out 2011 with the highest prescription week in its five and a half year history. The company has a number of innovative promotional strategies set for 2012, and generic competitors have failed to capture much of its market share thus far. Analyst Michael Napoli believes that the breadth of the product portfolio, coupled with the recent acquisition of Graceway Pharmacueticals, will help fuel solid earnings growth this year. He is particularly high on the prospects of Dysport (temporary improvement in the appearance of moderate to severe glabellar lines or wrinkles between the eyes), Vanos (relief of inflammation caused by psoriasis), and Restalyne (correction of moderate to severe facial wrinkles).
Mr. Napoli believes that the stock offers ample recovery prospects out to mid-decade. Income may not be an overwhelming component (current yield is 1.06%), but certainly adds to MRX’s appeal. The company’s financials are in solid shape, and it may reward shareholders in the form of dividend increases if the drug candidates acquired in the Gateway purchase come to fruition.
UnitedHealth Group (UNH) is a diversified health and wellbeing company. It offers products and services to more than 70 million individuals through two business segments: United Healthcare, the largest health insurer in the United States, and OptumRX, a pharmacy benefits manager (PBMs process and pay prescription drug claims, develop and maintain formulary contracting with pharmacies, and negotiate discounts and rebates with drug manufacturers). During 2010, UNH managed approximately $125 billion in aggregate health care spending. Revenues are derived from premiums on risk-based products; fees from management, administrative, technology and consulting services; and sales of products and services.
The company has seen earnings growth increase considerably over the past few years. Most recently, UNH bounced back from a hiccup in the third quarter, to easily best December-period expectations. The results were largely driven by a more favorable medical loss ratio (medical costs as a percentage of premium revenues). Furthermore, revenue remains on an upward trajectory, thanks to market-share gains, and ongoing enrollment strength, particularly in the government business (Medicare Advantage, Medicaid, Medigap, Part D).
Some in the investment community are worried about margins. Indeed, a PBM customer, Medco Health Solutions (MHS), is set to merge with Express Scripts (ESRX), and has indicated that it won’t renew its contract with United. In response, UNH is investing $155 million to transition those services to OptumRX. We look for momentum in the health services segment to offset some of the pressure. Once the transition is complete (probably later this year), profitability should improve materially.
A history of earnings surprises suggests that UNH’s earnings-per-share guidance may be conservative. The company has a solid balance sheet, lined with cash that ought to allow it to continue buying back shares, consummate acquisitions, and pay dividends. The income component is a nice touch (current yield is 1.24%) for those intrigued by the stock’s 3- to 5-year appreciation potential, and Above Average Safety rank.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.