Thursday, August 2, 2012

A Bunch of Defensive Growth Stocks

Anyone living in the UK in the 80’s and 90’s, couldn’t help but notice an atrocious game show called Bullseye. The most infamous, of its many faults, wasn’t the unwitting appearance of a serial killer on the program. Nor was it the awarding of a skiing holiday to a wheelchair bound contestant. It wasn’t even the speedboat accorded to a couple who lived about 80 miles from the sea.

No. It wasn’t any of these things.  It was the almost weekly occurrence when, after failing to win the mystery star prize, the host would reveal it, and then ask the crestfallen contestants to ‘come and see what you would have won’.

Why do I risk boring you with this drivel? Because most of the following stocks will somewhat make you feel like the Bullseye contestants. They are all great stocks with good defensive growth prospects, but they have all been bid up to a level that suggests they would need a pull back to become attractive. However, there is one stock that I think remains good value and, the good news is that investors can monitor the other stocks with a view to buying in at cheaper prices in future.

Defensive Growth Stocks

What these six disparate companies all have in common is the ability to generate revenue and margin growth, despite the possibility of a downturn. This is because their growth drivers are part of a longer term structural trend. All of them, have been on a strong run this year.

It is not hard to see the standout candidate and, I will come back to CVS Caremark $CVS later on.

As for the others, Novo Nordisk $NVO is a Danish healthcare company with a focus on diabetes. Its long term driver is the confluence of growing middle classes in emerging markets adopting western lifestyles and diet. In other words, in places like India and China, a rural grain eating populace is turning into an urban sedentary one that is increasingly eating processed foods. The result is a steadily growing trend in diabetes. Unfortunately, all of this is well known in the marketplace and, it is hard to argue that Novo Nordisk is particularly cheap. Nevertheless, any significant pullback could be seen as an ideal opportunity to buy into an exciting long term growth story.

Turning to the second company on the list, with Perrigo Company $PRGO we have a developer and manufacturer of private label over the counter (OTC) healthcare products and also generic pharmaceuticals. What makes Perrigo so interesting, is that OTC pharma tends to be cheaper and, in a price conscious health care environment, this is a major plus.

Moreover, private label products tend to come with a higher margin to the stores because they (stores) are taking a bigger share of the overall price. This is despite the price of private label products being lower than national branded products. The opportunity for Perrigo is significant, but then again so is the company’s current evaluation!

A similar story could be said for the next two companies, Allergan $AGN and France’s Essilor. The former is a specialty healthcare company that has a focus on facial and body aesthetics. In other words, Botox and breast implants. Now, considering the increasing social acceptance of these products and the growing aging population, it is reasonable to expect that Allergan has good growth prospects for years to come.

A similar conclusion could be reached with Essilor, which is the world’s largest manufacturer of ophthalmic lenses and, also the inventor and leading player in presbyopia treatment. Presbyopia is an age related condition whereby the eye loses its flexibility and cannot focus on near term objects as it used too. Clearly, Essilor is also well positioned to benefit from the aging population.

From an industry perspective, TJX Companies $TJX is the odd man out as it is not in the healthcare sector. It is an off-price retailer that has seen a surge in popularity as consumers have become more cost conscious over the last few years. In addition, upscale stores will have wanted to protect their margins in their own stores, so many have been more willing to distribute their stock of invesntory to TJX in order to avoid discounting in their own stores. With the prognosis for the US economy being one of a slow growth path, the outlook for TJX looks strong.

However, the evaluation of TJX is fully up with events. It is greatly tempting to hold TJX -at least I think so because I did until recently- but given any earnings disappointment, the downside could be sharp.

The Value Play

 All of which, leaves pharmacist and pharmacy benefit manager (PBM) CVS Caremark. A few reasons why I like the stock.
  • The dispute between Walgreen and Express Scripts (PBM) has led to Caremark winning pharmacy customers in an industry with extremely high retention rates
  • CVS has been aggressively targeting rising Medicare spending
  • Management is conservative with guidance from gains over the Walgreen/Express Scripts dispute
  • Many leading drugs are going off-patent in the next few years and generics are gaining in popularity
  • CVS is boosting private label products, which typically come with higher margins
  • The long term demographic trend
Expanding on the point about generics, it is worth considering that pharmacies tend to buy brand name drugs via wholesalers. However, with generics, the larger co’s like CVS can negotiate direct with the manufacturers. In addition, they tend to have more negotiating clout with them because there is more competition. I see this as an opportunity for CVS to boost margins.

Similarly, with the expansion of its own private label products, there is an opportunity here. I think that – in austere times- people are more willing to try cheaper alternatives to brand name products. Indeed, this is a long term trend that is likely to happen as there is upward pressure on the volume of healthcare products but downward emphasis on pricing. I like the way that CVS is preparing for these new realities.

On the downside, there are concerns being addressed about the opacity of pricing with the PBM market, and investors need to look out for future political pressures. No matter, for now, the environment looks favorable. 

From an evaluation perspective, CVS is a huge cash generator and, according to analysts’ consensus, it’s quite capable of growing earnings in the double digits for the next few years. All of which makes CVS Caremark a stock well worth taking a close look at.

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