Is big pharma a big pain?
Three top fund managers who appeared on a global-investing panel last week agreed on many key issues. But the appeal of the pharmaceutical giants--and of health-care stocks in general--was not one of them.
Speaking at the Morningstar Investment Conference in Chicago, David Winters of Wintergreen Fund, which can invest in the United States as well as abroad, said that he disliked the outlook for health-care firms in general because governments have focused so much attention on them. That has resulted, he said, in the "crushing" of their profitability. Why invest in health care when the potential for gain is so much greater in other areas?
A look at the latest Wintergreen portfolio shows that Winters is putting his money where his mouth is: The health-care sector gets exactly 0% of assets.
When it comes to the big pharmaceutical companies, Rajeev Bhaman, who has managed Oppenheimer Global since 2004, agrees wholeheartedly with Winters' dire assessment. The drug giants have done no innovation in the past 10 years, he declared. The innovative treatments have come from biotech firms. So why, then, is pharma giant Roche near the top of his fund's portfolio? Because of its stake in Genentech, the successful biotech company. When pressed by Winters, Bhaman conceded that he didn't like the price that Roche recently paid to take control of the portion of Genentech that it didn't already own, but he thinks that the deal will work to Roche's benefit nonetheless.
More broadly, he, like Winters, is wary about government intervention in the economic sphere. He conceded that such efforts are usually well-intentioned, but he had little good to say about the results. Bhaman said that India--his birthplace--had been held back for 50 years by unwise and heavy-handed government policies, and he does not want to see the same thing happen in the United States. He implied, though, that he feared the tide is headed in that direction.
By contrast, Diana Strandberg of Dodge & Cox Global and Dodge & Cox International sees big pharma as an ocean of opportunity. She said that she understands the concern over the unimpressive results from their extensive research and development efforts, and over the fact that patents on many lucrative drugs have expired or will soon do so. But, she said, those worries have pushed the valuations of these companies to attractively low levels. Firms such as the UK's GlaxoSmithKline, Merck, and Pfizer aren't just cheap, she added, they boast great cash flow and healthy dividends and have room to make further cost cuts.
In addition, Strandberg likes big pharma's distribution networks. Using Warren Buffett's term, she said that they have a "moat" in that realm, enabling them to profit from distributing promising drugs from smaller biotech firms when their own drug pipelines are dry. Meanwhile, the hefty dividends allow her to collect a nice income while she waits for their research efforts to pay off. No surprise, then, to see Novartis, Sanofi-Aventis, and Glaxo all showing up in the top 10 of Dodge & Cox International's latest portfolio. In fact, Novartis holds the top spot with 3.8% of assets.
Isn't Strandberg worried about government actions? She said that she tries to stay open-minded on the question of government involvement, explaining that Dodge & Cox focuses on the consistency of the playbook, in her words. It is "capriciousness" in government actions that can make an area tough to negotiate, she said--so apparently she and her colleagues do not consider the danger of such inconsistency great enough at this point to keep them away from big pharma.
(Dodge & Cox wasn't alone in that view: Bruce Berkowitz of Fairholme Fund, speaking at a different Morningstar panel, also highlighted the opportunities in health care. Berkowitz certainly has high hopes for one pharma giant in particular, having sunk more than 15% of Fairholme's assets into Pfizer.)
Meanwhile, the three global managers agreed completely on a different issue: the appeal of emerging markets. They all think that growth rates in emerging markets will be much higher in coming years than in developed countries and that fund managers must seek the best ways to tap into that trend. Winters focused on Asia in particular, saying that his large stake in Jardine Matheson, a financial house based in Southeast Asia, is a play on that region's growth.
Not every attempt to profit on emerging-markets growth has to come from companies based in emerging markets. Winters cited Schindler Holdings, a Switzerland-based maker of elevators and escalators, which he said stands to benefit greatly from the continuing urbanisation of less-developed regions. Strandberg said that Nokia was one of her fund's most notable plays on emerging markets. And Bhaman said that Colgate-Palmolive, which he called a "fantastic" company, has tremendous room for growth in areas such as Latin America and India.
Gregg Wolper is a senior mutual-fund analyst with Morningstar.com.
