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  1. Home
  2. / Investing
  3. / Healthcare

Watch Beaten-Down Drug Companies, Hospitals in 2017

There may be some diamonds-in-the-rough among pharmaceutical consolidators and hospital chains.
By JIM COLLINS
Dec 29, 2016 | 04:00 PM EST
Stocks quotes in this article: PFE, MRK, JNJ, VRX, ENDO, PRGO, MYL, THC, CYH

Following on from my column yesterday, here are a few sectors that have produced multiple laggards in this year's rally. The Trump Jump has not been kind to every sector, especially certain health-care subsectors. Questions about pricing and reimbursement are dogging stocks of pharmaceutical consolidators and some hospital chains. The Affordable Care Act is DOA, in my opinion, but what stands in its place is still to be discovered. The blue chips like Pfizer (PFE) , Merck (MRK) and Johnson & Johnson (JNJ) have lagged since the election but not so much that it would dent one's portfolio. And all three offer solid yields for long-term holders.

No, the great pain -- and, it must be said, potential opportunity, for the bottom-fishers among the investment community -- has come from companies whose very business models are under pressure from threats to control pharmaceutical pricing and deregulate Obamacare. I'm not recommending these stocks, rather presenting them as potential diamonds in the rough (and in some cases, especially Valeant Pharmaceuticals (VRX) , 2016 was terribly rough) for those investors looking for mean-reversion trades.

It all seemed so simple. Buy drug companies, harvest operating efficiencies and benefits of scale and watch profits drop to the bottom line as new management pushes through price increases on the acquired products. Well, 2016 showed us that it's not that simple. Want proof? Run a four-stock comparison with Valeant, Endo International (ENDO) , Perrigo (PRGO) and Mylan (MYL) . Their year-to-date performances are certainly enough to send one reaching for the medicine cabinet: VRX down 86%, ENDP down 74%, PRGO down 43% and MYL down 35%.

Is it possible, however, that the often-misplaced and occasionally hilarious, sanctimonious faux populism of election season is just going to die away like a fading Clinton/Kaine yard sign? Personally, I hope so, and if it does that will give these companies a chance to tune their business models to a reality in which price increases are not a given and margins must be won. Also, as Real Money Godfather Jim Cramer has mentioned many times, companies that grow only via acquisition must be scrutinized very closely when it comes to purchase accounting. Very, very, very closely. It is always the elephant in the room when it comes to owning any of these stocks, and certainly for VRX it has been the company's Achilles' heel. So, the key for 2017 is for these managements to focus on internal restructuring and sustaining profitability in an environment in which acquisitions are not so easy.

Similarly, for companies like Tenet Healthcare (THC) (down 51%) and Community Health Systems (CYH) (down 78%), the ACA's colossal failure and current status in mid-death spiral has produced nauseating year-to-date stock performances. But -- the market is clearly asking -- what if the alternative to Obamacare is actually worse? That's where we stand today. It's a scary position, and much like the specialty pharma companies above, a key part of the Tenet and Community Health Systems growth stories has always been acquisitions. The Obama administration's misguided, narrowly-focused and extremely selective prosecutions of antitrust statutes have affected health-care broadly. But I don't think that's coloring sentiment among health-system managements as we head into 2017. I think they are more concerned about who is going to pay them to care for their patients and where those patients will come from. Until these basic questions are answered, it's just not a good time to be consolidating hospitals. Again, though, the stocks to buy in 2017 would be ones where management has committed to internal restructuring in an uncertain environment, not focusing on growth through acquisition.

So, in those two health-care sectors, pharmaceutical consolidators and some hospital chains, there's no "screaming buy," but the stock prices have been so horrible that I intend to educate myself on the fundamentals of the six individual companies I mentioned as potential 2017 trading ideas. In tomorrow's column, I'll give two names that are even more beaten down than Valeant ... but much closer to a "sure thing" for trading profitably in the New Year.

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At the time of publication, Collins had no positions in the stocks mentioned.

TAGS: Investing | U.S. Equity | Healthcare | Stocks

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