Inside Wall Street: Four Cash-Rich Pharma Picks From Goldman Sachs
The health care industry is in flux, largely plagued by slowing market growth. But some analysts see opportunities even amid such challenging conditions as patent expirations and more difficult environments for pricing and restrictive regulations. One problem: Management teams across health care have yet to respond to the new reality, according to a Sept. 21 study by the Goldman Sachs (GS) health care team led by Jami Rubin.
This is so even as the gross cash amounts that health care companies hold should increase 70% to $379 billion in 2013 from 2009's $225 billion, Goldman estimates. What to do with such enormous cash hoard? Goldman's salient advice: Companies could benefit greatly by aggressively returning cash to shareholders via share buybacks and/or dividends, as well as through mergers and acquisitions, including spin-offs or breakups of certain assets.
In addition, Goldman lists four health care companies that it believes should benefit from such shareholder-value enhancements and that it sees having further upside potential in their stocks. They are:
Pfizer (PFE), the world's largest pharmaceutical company
McKesson (MCK), a major provider of supply management and information technologies to health care companies
Medtronic (MDT), a global maker of such medical devices as pacemakers and defibrillators
Forest Laboratories (FRX), which develops and makes both branded and generic-drug products
Goldman says its buy recommendation on Pfizer is based on the market's low expectations despite Pfizer's high free cash flow and signs that management is becoming more aggressive with its cash returns through buybacks and dividends. Currently trading at $17 a share, Pfizer could rise by 11% in 12 months, according to Goldman estimates. "But we see significantly more upside potential if its management takes more dramatic corporate actions," says Goldman's Rubin.
As an example, Goldman figures that If Pfizer were to split off its non-bio-pharma divisions, it would realize up to a 16.5% accretion to its 2010 earnings. If Pfizer were to be valued based on its units as stand-alone companies, the stock's theoretical valuation could rise to $24 a share, or a 40% upside from its current price.
The Market Will Catch On, Eventually
Goldmans thinks McKesson is another stock that the market has unjustifiably undervalued. Investors, it notes, fail to appreciate the value of its distribution unit's long-term fundamentals, thanks to a record number of generic-drug launches, coupled with the added diversification of McKesson's higher-growth info-tech business. The value of this IT segment, Goldman's analysts say, isn't fully reflected in McKesson's current stock price.
In time, Goldman expects the market to recognize the unit's true worth because the firm expects McKesson's IT business revenues and profits will accelerate in late 2011 and into 2012. Currently trading at $63 a share, the stock should climb to $81 in 12 months, figure Goldman's analysts.
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Medtronic is one medical stock that Goldman rates neutral (hold) with a 12-month price target of $35. However, based on a sum-of-the-parts analysis, the value of the stock, now trading at $33, would increase to the $43 to $44 range. That's the upside Goldman sees if Medtronic's various segments -- cardiovascular devices, spine, neuro-modulation, diabetes and surgical technologies -- were valued on a stand-alone basis. The Goldman team notes that Medtronic should theoretically be able to use its scale and diversity to benefit from the current trend of hospitals consolidating vendors and centralizing purchasing systems.
Forest Labs, currently trading at $31 a share, is also rated neutral by Goldman, with a 12-month target of just $32, based mainly on management's uncertain plans about how to use the $3.9 billion cash on its balance sheet. But if management takes a more aggressive stance in this regard, the stock's worth would be enhanced, according to Goldman.
Bold Moves Needed
What could Forest do? Possible moves are buying back shares or starting to pay dividends. A share purchase could be about 35% accretive to earnings, estimate the analysts. Or Forest could pursue an acquisition to expand its platform into higher-growth markets outside the U.S. Goldman warns that failure to take such bold moves would further erode shareholder value and weigh heavily on the stock.
No doubt, Big Pharma needs to bolster its long-term outlook, says Goldman, because it has been a "poor allocator" of shareholder capital over the past 10 years. And investors should strike while these four stocks are selling on the cheap to take advantage of their potential upward mobility. Indeed, they're currently among the lagging but potential winners in complex universe of health care.
