The stock market has come a long way since the Great Recession, which has some investors thinking it could be due for a substantial cooling-off period. Yet on the basis of forward price to earnings as of June 7, and per market analytics company Yardeni Research, the S&P 500‘s forward P/E of 16.7 looks reasonably low.
Of course, if you think that’s low, you’re probably going to love the healthcare sector, which has a forward P/E of just 15.2. That’s lower than consumer staples, information technology, energy, and industrials! Investors who take the time to scour the healthcare sector could uncover some significant bargains.
With this in mind, we asked three Motley Fool investors to name one healthcare stock that’s tops on their list for the month of June. These three mid-cap stocks made the cut: royalty drug company Innoviva (NASDAQ: INVA), mental illness treatment center operator Acadia Healthcare (NASDAQ: ACHC), and health savings account provider HealthEquity (NASDAQ: HQY).
Possibly the cheapest drug stock you can buy today
Sean Williams (Innoviva): There’s usually a reason why a company is cheaper than its peers, but even those reasons need to be revisited from time to time.
Unlike most drug developers, Innoviva is a royalty-based company. Having spun off Theravance BioPharma years ago, Innoviva now sits back and collects royalties on the net sales of long-lasting COPD and asthma therapies jointly developed with GlaxoSmithKline (NYSE: GSK). You probably know these drugs as Breo Ellipta, Anoro Ellipta, and the newly approved Trelegy Ellipta.
What got Innoviva in trouble was the fact that, following its split from Theravance BioPharma, it took out a loan for $450 million, much of which was used to start paying a quarterly dividend of $0.25 to shareholders. Unfortunately, Breo Ellipta, followed by Anoro Ellipta, stumbled rather than surged out of the gate. Their higher price points made obtaining insurer coverage an initial challenge. Furthermore, making physicians aware that there were new long-acting asthma and/or COPD options available took time. The end result was a slower-than-expected uptake in sales for both drugs, and therefore weaker royalty revenue for Innoviva. The company wound up halting its quarterly dividend after little more than a year.
However, Innoviva has done a complete 180 in recent quarters and is looking like quite the value for healthcare investors. Sales for Breo and Anoro grew by 14% and 68%, respectively, from the prior-year quarter, according to GlaxoSmithKline’s first-quarter operating results. This translated into a 28% increase in year-over-year net royalty revenue for Innoviva and a 39% jump in income from operations. Translation: Breo and Anoro are finally on track.
Additionally, after refinancing its Term B loan in 2017, the company made a $120 million prepayment on that loan in February 2018. It now carries just $120.6 million in senior secured loans, though it does have roughly $364 million in convertible notes to eventually attend to. It’s possible that, given the company’s low-cost structure and growing royalty revenue, a quarterly dividend could return by 2020, in my best estimate.
At some point, investors have to forget Innoviva’s poor decision years ago and focus on the fact that its royalty sales and income are growing with each passing quarter. At less than seven times next year’s EPS forecast from Wall Street, and with an outside chance of $3 per share in EPS by 2021, I’d suggest that Innoviva is the healthcare stock you should consider buying in June.
Not all healthcare is pharmaceuticals and surgeries
Chuck Saletta (Acadia Healthcare Company): While physical ailments typically get the lion’s share of attention when it comes to healthcare discussions, there’s more to health than just a person’s body. Mental illness and addiction are very real health problems people face as well, and Acadia Healthcare Company is a leading provider of treatments for those types of issues.
The need for treatment is real, and it will be with us as long as people struggle with those challenges. That long-term need for Acadia Healthcare’s services provides reason to believe that its business will be around for quite some time, and its valuation is what makes it worth considering buying this June.
Acadia Healthcare currently trades at less than 14 times its expected forward earnings, and those earnings are anticipated to grow by almost 12% annualized over the next five or so years. That makes the company a reasonable bargain. In addition, with a debt-to-equity ratio of just under 1.2, Acadia Healthcare has a solid financial footing underlying its operations. That solid balance sheet gives reason to believe the company can survive even if the future isn’t as rosy as currently hoped.
That’s important, because while there is a need for Acadia Heathcare’s services, the reality is that its earnings aren’t quite as consistent or predictable as many other areas of healthcare. Over time, its business should do well, but investors should know that it’s that potential of missing over the short term that makes its shares available at a bargain price today.
Pricey but worth it
Brian Feroldi (HealthEquity): As healthcare costs have spiraled out of control, many employees and employers have looked for ways to lower their bills. One way to do so is to make use of high-deductible health plans. These types of plans offer premiums savings of about $1,900 annually when compared to traditional plans, which is a big reason why they have exploded in popularity over the last decade.
One advantage of signing up for high-deductible health plans is that you become eligible to enroll in a health savings accounts (HSAs). These plans offer triple-tax-free savings incentives that have made them an easy choice for anyone who is eligible.
HealthEquity is one of the country’s leading providers of HSA accounts. The business has grown like a weed in recent years as more consumers become educated about the many benefits of signing up for an HSA.
Growing enrollment has combined with the company’s rock-solid business model to create mouth-watering financial results. For example, last quarter HealthEquity’s revenue grew 26% on the back of a 24% jump in total HSA members. Better yet, the business is scaling nicely as margin expansion helped drive EPS growth of 63%. The broad-based prosperity allowed management to increase its revenue and net income guidance for the full year.
Since the demand for HSAs is likely to remain strong for years to come, I think it is likely that HealthEquity’s strong growth rates will be able to continue for the foreseeable future.
The only knock that I have against investing in this business right now is that Wall Street has caught on to its growth trajectory and priced shares accordingly. The stock currently trades for nearly 62 times next year’s earnings estimates and more than 21 times trailing sales. Lofty valuations often come with sky-high expectations, so if the company fails to live up to its potential, then shareholders could be in for a world of pain.
In spite of the risks, I think that this company has so much going for it that it is still worth opening up a small position today. Just be sure to brace yourself for a wild ride before you make the plunge.
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Brian Feroldi owns shares of HealthEquity. Chuck Saletta has no position in any of the stocks mentioned. Sean Williams has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.