Fall 2011
HEALTH CARE
Colin McMahon
Balaji Natarajan
Thomas O‟Neill
Abinav Sankar
Agenda
• Recommendation
• Sector Overview
• Business Analysis
• Economic Analysis
• Financial Analysis
• Valuation Analysis
• Summary
Recommendation
• Increase the weight in the health care sector by 100 bps
bringing the weight to 12.77%
Sector Overview
Portfolio comparison
Sector
S&P Weight
SIM Weight
Difference
Consumer Discretionary
10.65%
8.74%
1.91%
Consumer Staples
11.05%
12.24%
-1.19%
Energy
12.27%
12.41%
-0.14%
14%
10.06%
3.94%
Health Care
11.51%
11.77%
-0.26%
Industrials
10.56%
9.08%
1.48%
Information Technology
19.68%
21.69%
-2.01%
Materials
3.56%
3.25%
0.31%
Telecom
3.02%
4.12%
-1.10%
Utilities
3.70%
2.57%
1.13%
Financials
We are currently 26 bps overweight in the healthcare sector as compared to
the S&P portfolio
Performance of the sector
MTD
QTD
YTD
TOTAL RETURNS
N/A
2,156.00
0.66%
11.66%
1.97%
1,14,86,897.90
1,261.12
0.62%
11.46%
0.28%
S&P 500 (TR)
PRICE RETURNS
S&P 500
PRICE RETURNS BY SECTOR
Energy
14,39,393.00
531.96
2.72%
20.14%
4.97%
Materials
4,16,165.80
222
2.29%
20.29%
-7.35%
Industrials
12,09,017.83
289.44
0.58%
14.58%
-3.88%
Cons Disc
12,19,553.52
308.89
0.27%
12.11%
4.52%
Cons Staples
12,67,366.30
321.32
0.44%
4.76%
5.84%
Health Care
13,16,052.93
388.9
0.15%
5.76%
6.61%
Financials
15,80,016.04
179.44
-1.17%
12.82%
-16.45%
Info Tech
22,63,592.78
424.66
0.74%
12.29%
4.97%
Telecom Svc
3,49,022.74
125.78
1.30%
3.09%
-2.30%
Utilities
4,26,716.97
178.35
0.89%
4.44%
11.93%
Industries within the sector
Sector: Healthcare
Industries
Biotechnology
Diagnostic Substances
Drug Delivery
Drug Manufacturers - Major
Drug Manufacturers - Other
Drug Related Products
Drugs - Generic
Health Care Plans
Home Health Care
Hospitals
Long-Term Care Facilities
Medical Appliances &
Equipment
Medical Instruments &
Supplies
Medical Laboratories &
Research
Medical Practitioners
Specialized Health Services
Market
ROE
Div.
P/E
Cap
% Yield %
52193.8
B
19.18 16.2
3.8
D/E
P/B
Net Profit
margin
P/FCF
69.78 18.39
16.15
-71.91
46.2 7.38
24.49 4.99
75.64 -9.05
11.9
2.7
-1.2
155.6
134.7
-53.9
1283.5B 57.8
11.1B
179.6
59.2B
0
48009.6
B
17.2
185.0B
28.9
21.6B
36.5
818.6B
50.1
165.2B
11.8
4.5B
24.1
326.5B
10
8.3B
63.7
8.7
2.5
0
1.96
3.57
0.4
15.8
13.4
14.9
7.6
17.2
12
144
2.4
4.02
1.21
0.79
0
1.26
2.45
0.23
0.97
71.03
282.69
57.85
39.06
62.54
51.49
60.8
187.77
19.89
17.85
13.95
-21.98
10.08
-11.11
-2.49
4.05
16.7
14.1
9.5
6
4.5
5.7
4.3
0.9
-88.1
-193.8
41.3
-81.6
46.2
-381.6
489.9
-13.8
822.1B
16.3
14.1
1.85
30.07
6.06
13.7
204.1
338.5B
24.1
13.5
1.65
48.87 16.88
13.6
155
118.7B
3.3B
18.3B
202.8
7.6
17.3
1.5
12.7
17.6
0.84
8.32
2.02
59.19 -9.45
45.59 5.59
117.66 -10.02
0.8
4.3
9.4
-40.6
35.8
-63.6
Business Analysis
Various Industries in Healthcare
• Drug Developers
• Big Pharma
• Biotech
• Generics
• Facilities
Big
Pharma
Biotech
• Medical Devices
• Insurers
Generics
Major companies
Rank
Symbol
Company
Market Cap
(Billions of
dollars)
1
JNJ
Johnson & Johnson
173.68
2
PFE
Pfizer
150.82
3
NVS
Novartis
134.14
4
GSK
GlaxoSmithKline
113.31
5
MRK
Merk
113.31
11
AMGN
Amgen
51.32
15
TEVA
Teva Pharmaceuticals
Industries
34.86
Relative Healthcare Outperformance
Healthcare Stocks Best at Cycle Tops
Technical Analysis of Cycle Top
S&P vs 10-Yr Treasury
S&P vs China FXI ETF
Correlation between Real GDP and Health Care Index
Health care moves
similarly with GDP, but
not a high correlation
Healthcare Growth Trends: Pharmerging
Markets
Global Middle Class Statistics
• Middle class is growing globally, with more people able
to access modern medical treatments
•IMS Health expects a 14-17% pharmerging market
growth rate until 2014, compared to 3-6% for developed
markets
Patent Loss
• Numerous patents are set to expire in 2015, adding to the
generic market
• Some major patents set to expire include
Generics Growth
• With all of the patents expiring, generic drugs are
expected to grow from an $81 billion market in 2008 to a
$168.7 billion market in 2014
• Compounded annual growth rate = 15%
• This trend will continue as governments and insurers are
trying to reduce healthcare costs
Aging Population
Population 65+ by Age: 1900-2050
Source: U.S. Bureau of the Census
10,00,00,000
9,00,00,000
8,00,00,000
Number of Persons 65+
7,00,00,000
6,00,00,000
5,00,00,000
4,00,00,000
3,00,00,000
2,00,00,000
1,00,00,000
0
1900
1910
1920
1930
1940
1950
1960
Age
65-74
1970
Age
75-84
1980
Age
85+
1990
2000
2010
2020
2030
2040
2050
Porter‟s five forces
Buyer Power –
Medium
Supplier Power –
Low
Competitive
Rivalry - High
Threat of substitutes –
Low
Barriers to entry –
High
Healthcare Reform
• Coverage will be extended to 32 million Americans,
however…
• An excerpt from JNJ 10-K
• “Medicare rebates increased from 15.1 to 23.1% reducing 2010
sales revenue by $400 million”
• “Beginning in 2013, the company will be required to pay a 2.3%, tax
deductable excise tax, with an impact of $150 to $200 million”
FDA Regulation
• “In general, survey respondents viewed regulatory processes for making
products available to patients as unpredictable and characterized by
disruptions and delays.”
• “Respondents reported that their devices were available to US citizens on
average nearly two full years later than patients in other countries, due to
delays with the FDA”
– American Medical Technology Association
Conclusion of Regulation
• Expect revenues to decrease from lower medicade
benefits
• Expect higher taxes of close to 2% beginning in 2013
• Expect higher research and development costs with
continued regulation from FDA
• Expect more growth in medical devices as product
development times are 33-50% shorter and less FDA
approval risk
Economic Analysis
Real GDP & Health Care
S&P & Health Care
Consumer Spending & Health Care
CPI & Health Care
Employment & Health Care
Economic Factors
Demographics
 Aging Population
 Baby Boomers
Health care reforms

National Health Expenditure

Medicare and Medicaid

Insurance coverage
Unemployment
Demographics
1. Aging population
Projected old age population (in millions)
 The „65 years and older‟
demographic increases at a CAGR
of 3% till 2030
 There will be an 80 % increase in
the „65 and older‟ demographic at
2030
500
450
400
350
300
250
200
150
100
50
0
2010
2015
2020
2025
Total Population
2030
2035
2040
65 years and over
2045
2050
2. Baby boomers
Projected Population Demographic (in millions)
220
200
180
160
140
120
100
80
60
40
20
2010
2015
2020
Under 24 years
2025
2030
24 to 64 years
2035
2040
2045
2050
65 years and over
 Baby boomers coming of age which results in expanding middle age population
 Increased drug use across all the age groups.
Health care reforms
1. National Health Expenditure – Trend and Forecast
NHE Forecast (in millions)
5
4.5
4
3.5
3
2.5
2
1.5
1
0.5
0
1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019
NHE
Forecast
Source: CBO
• NHE - Expected to increase at a rate of 6%(annual)
• Total spending on health care would rise from 16% of GDP in 2007 to 25% in
2025, 37% in 2050, and 49% in 2082.
2. Medicare and Medicaid
• Federal spending on Medicare and
Medicaid would rise from 4% of GDP in
2007 to 7% in 2025, 12% in 2050, and
19 percent in 2082.
3. Insurance Coverage
% of Population Uninsured
17%
16%
15%
14%
13%
12%
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
uninsured people(in %)
• The trend is expected to increase in the short term – a worrying factor.
Unemployment
Unemployment rate forecast
11%
10%
9%
8%
7%
6%
5%
Unemployment
Forecast
Jan-16
Jun-16
Aug-15
Mar-15
Oct-14
May-14
Dec-13
Jul-13
Feb-13
Sep-12
Apr-12
Nov-11
Jun-11
Jan-11
Aug-10
Mar-10
Oct-09
May-09
Dec-08
Jul-08
Feb-08
Sep-07
Apr-07
Nov-06
Jun-06
Jan-06
Aug-05
Mar-05
Oct-04
May-04
Dec-03
Jul-03
Feb-03
Sep-02
Apr-02
Nov-01
Jun-01
Jan-01
4%
Source: CBO
• Unemployment rate has a negative correlation of -0.5 with the HCX
• Increased Employment rate will increase the insurance coverage benefitting
the Healthcare sector.
Unemployment
11
280
10
Low
Real GDP
Forecast
High
Low
May-16
290
Sep-15
12
Forecast
High
Jan-16
Apr-15
Jul-14
Oct-13
Jan-13
Apr-12
Jul-11
Oct-10
Jan-10
Apr-09
Jul-08
Oct-07
Jan-07
Apr-06
Jul-05
Oct-04
Jan-04
Apr-03
Jul-02
Oct-01
Jan-01
Jan-16
Mar-15
May-14
Jul-13
Sep-12
Nov-11
Jan-11
Mar-10
May-09
Jul-08
Sep-07
Nov-06
Jan-06
Mar-05
May-04
Jul-03
Sep-02
Nov-01
Population
Jan-15
300
Sep-13
13
May-14
310
Jan-13
14
May-12
320
Sep-11
15
Jan-11
330
May-10
16
Sep-09
Jan-09
May-08
Sep-07
Jan-07
May-06
High
Sep-05
Jan-05
May-04
Forecast
Sep-03
Jan-03
May-02
Sep-01
Population
Jan-01
340
Jan-01
Forecasts
Real GDP
Low
Unemployment
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
Source: CBO
HCX
Forecast
High
Low
• The volatility is less as compared to S&P 500 due to positive trend in
macroeconomic factors
• In the short term HCX can be expected to do well
Mar-16
Oct-15
May-15
Dec-14
Jul-14
Feb-14
Sep-13
Apr-13
Nov-12
Jun-12
Jan-12
Aug-11
Mar-11
Oct-10
May-10
Dec-09
Jul-09
Feb-09
Sep-08
Apr-08
Nov-07
Jun-07
Jan-07
Aug-06
Mar-06
Oct-05
May-05
Dec-04
Jul-04
Feb-04
Sep-03
Apr-03
Nov-02
Jun-02
HCX - Forecast
600
500
400
300
200
100
0
Financial Analysis
Revenue and Earnings outlook
• Long-term growth rates are 8% for revenue and earnings
• In comparison 5 year historical growth rates are 9%
Revenue and Earnings by industry
Earnings growth
• Earnings have seen steady growth, fairly consistent with
respect to sales
Key Operating Statistics
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
EBITDA
Margin
17.8%
17.3%
17.1%
17.1%
16.4%
16.7%
16.4%
16.9%
16.3%
16.4%
Net Profit
Margin
10.4%
10.4%
10.0%
9.9%
9.4%
10.2%
10.1%
9.7%
9.8%
9.9%
Return
on equity
29.3%
22.5%
22.4%
22.4%
21.7%
22.1%
22.9%
24.1%
21.7%
21.2%
Net profit margin
• Profit generated from each dollar of sales
• Net profit margins range 9.4%-10.9%
Net profit margin relative to S&P 500
• Health care sector has been slightly more profitable than
the overall market
Return on equity
• Measures profitability of funds employed by shareholders
• Has decline from 29.3% to 20.9% over the past decade
Return on equity relative to S&P 500
• Despite a decline in overall profitability for shareholders,
health care continues to outperform the S&P 500
Cash flow
• Cash flow has steadily increased over the past 10 years
• Important measure for solvency
Health Care profitability
• As shown in the previous slides profitability is declining
• Despite contracting margins health care remains more
profitable than the overall market
Valuation Analysis
Healthcare Valuation
Absolute Basis
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
29.4X
25.9X
8.7X
3.5X
22.9X
Low
9.9X
10.0X
2.2X
1.0X
8.6X
Median
18.3X
17.3X
3.9X
1.8X
13.6X
Current
11.7X
11.2X
3.3X
1.2X
8.6X
VS S&P 500
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
1.4X
1.2X
8.7X
2.4X
1.9X
Low
0.7X
0.7X
2.2X
0.9X
0.9X
Median
1.1X
1.1X
3.9X
1.2X
1.3X
Current
0.9X
0.9X
3.3X
1.0X
1.0X
Biotechnology
Biotechnology Absolute
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
57.5X
48.5X
48.5X
15.7X
48.2X
Low
12.1X
11.3X
11.3X
3.8X
9.2X
Median
23.3X
20.7X
20.7X
6.5X
17.4X
Current
14.3X
14.3X
12.7X
4.4X
11.2X
Biotechnology VS S&P 500
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
2.5X
1.9X
3.5X
10.4X
3.8X
Low
0.8X
0.8X
1.2X
3.0X
1.0X
Median
1.5X
1.4X
1.5X
4.7X
1.7X
Current
1.1X
1.0X
1.6X
3.7X
1.3X
Pharmaceuticals
Pharmaceuticals Absolute
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
28.3X
25.2X
11.3X
5.6X
23.2X
Low
8.9X
9.3X
2.3X
2.0X
6.7X
Median
16.0X
15.6X
4.0X
3.5X
12.0X
Current
10.8X
10.7X
2.3X
2.4X
7.6X
Pharmaceuticals VS S&P500
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
1.4X
1.1X
3.3X
3.9X
1.9X
Low
0.6X
0.6X
1.0X
1.7X
0.8X
Median
0.9X
1.0X
1.4X
2.4X
1.1X
Current
0.9X
0.9X
1.2X
2.0X
0.9X
Medical Equipment
Medical Equipment Absolute
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
36.0X
31.4X
9.0X
5.5X
25.6X
Low
12.1X
11.7X
2.3X
2.0X
8.7X
Median
22.6X
21.1X
4.5X
3.7X
16.1X
Current
13.1X
12.4X
2.4X
2.3X
10.0X
Medical Equipment VS
S&P500
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
1.7X
1.5X
2.6X
3.6X
2.0X
Low
.82X
.79X
1.1X
1.9X
1.0X
Median
1.3X
1.3X
1.6X
2.6X
1.6X
Current
1.0X
.99X
1.2X
1.9X
1.1X
Healthcare Services
Services Absolute
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
32.5X
22.3X
5.7X
2.5X
19.1X
Low
13.1X
11.0X
2.4X
.5X
9.8X
Median
20.7X
17.9X
4.1X
.8X
14.4X
Current
15.2X
13.0X
5.2X
.5X
11.4X
Services VS S&P500
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
1.0X
1.5X
2.7X
1.7X
1.8X
Low
1.6X
.85X
.8X
.3X
1.1X
Median
1.2X
1.2X
1.4X
.6X
1.4X
Current
1.2X
1.0X
2.6X
.5X
1.3X
Technical Analysis
Summary
• Increase the weight by 100 bps.
• Short term Health care sector outperformance
• Less volatility as compared to the market
• Favorable macro economic factors
Questions?