Though much has been made about the patent cliff—shorthand for the expiration of the patents of a large number of drugs over a short period of time—we continue to believe that pipelines across much of the pharmaceutical space are flush with new drugs and therapies. Readers may have an individual favorite or two (or three) within the space (and there’s nothing wrong with that), but we think one of the best ways for investors to play the strong pipelines across the healthcare sector—and ongoing consolidation—is through the Health Care Select SPDR ETF (XLV), a holding in the Best Ideas portfolio.
The ETF boasts Johnson & Johnson (JNJ), Pfizer (PFE), Merck (MRK), Gilead Sciences (GILD), and AbbVie (ABBV) as its top 5 holdings, a gross expense ratio of just 16 basis points, and a tangible income stream via a 1.6% yield. We think broader diversification via the Health Care Select ETF allows participants to gain exposure to a ‘rising tide lifts all boats’ phenomenon that generally occurs in an industry where consolidation is pushing prices indiscriminately higher. Let’s take a look at second-quarter performance from the ETF’s top 5 holdings, which collectively account for ~37% of fund assets.
<< Health Care Select Sector SPDR Fund Fact Sheet
Note: Please be sure to access the 16-page reports and dividend reports of companies listed in this article.
Johnson & Johnson
<< Skip to second-quarter analysis
Pfizer
Pfizer’s second-quarter results continued to reveal a firm that is navigating through the patent cliff. Reported revenue and adjusted income dropped 2% and 6%, respectively, during the second quarter. The firm updated its 2014 adjusted revenue guidance to reflect expected multi-source generic competition for Celebrex in the US beginning in December, but its recently-launched products (Eliquis, Xeljanz, Xalkori, and Inlyta) continue to gain traction and its mid- and late-stage pipeline continues to progress.
The firm expects to complete its New Drug Application submission with the FDA for palbociclib in August and submitted a Biologics License Application to the FDA for its meningitis B vaccine candidate. Pfizer is also looking forward to the ACIP’s vote in August regarding a potential expanded recommendation for Prevnar 13 use in adults. The firm will be aggressive in buying back stock to support earnings per share, but we think Pfizer’s pipeline will ultimately deliver on expectations. Pfizer’s failed bid for AstraZeneca (AZN) also hits on the consolidation theme that is becoming more and more prominent in the healthcare space.
<< View Pfizer’s product pipeline
Merck
Merck’s second-quarter performance was better than that of Pfizer’s as the company showed modest gains in both sales and non-GAAP earnings per share. Merck continues to face headwinds related to the loss of market exclusivity for Temodar and Nasonex, but it, too, has a pipeline flush with potential new therapies. The company recently announced an agreement to acquire Idenix Pharma (IDIX)–a deal which will expand Merck’s portfolio of investigational therapies for hepatitis C. It also announced that Bayer AG agreed to purchase Merck Consumer Care in a $14+ billion transaction. Both of these events fit the general consolidation theme supporting a position in the Health Care Select ETF.
<< View Merck’s product pipeline
Gilead Sciences
Unlike Pfizer and Merck, Gilead is growing at a breakneck pace. Product sales during its second quarter increased to $6.41 billion compared to $2.66 billion in the same period last year. Net income for the second quarter came in at $3.66 billion, or $2.20 per diluted share compared to $772.6 million or $0.46 per diluted share in the year-ago quarter. The company continues to make significant progress thanks to strong Sovaldi sales. Gilead is building a war chest of cash on its balance sheet as it generated ~$4.2 billion in operating cash flow during the quarter. There continues to be a plethora of positive trial data across the firm’s antiviral product pipeline. On a fundamental basis, Gilead is quite exciting.
<< View Gilead’s product pipeline
AbbVie
AbbVie may have become the poster child for tax inversion following its $55 billion deal with Shire, but other companies across other industries have been doing the same. It’s possible that Pfizer may have taken AbbVie’s dubious honor if its deal for AstraZeneca had gone through, so we’re not pointing any fingers (nor do we have a political opinion on the topic of tax inversion).
Just a month prior to reporting better-than-expected second-quarter results, AbbVie raised its 2014 earnings-per-share guidance. Humira continues to be a strong performer (global sales increased 26%+ in the quarter), but the firm also revealed solid expansion from other key products including Synthroid, Sevoflurane and Duodopa. Management expects strong performance in the back half of the year and continued progression of its pipeline, including the expected US approval of its interferon-free HCV combination.
The combination of AbbVie and Shire is yet another example of consolidation in the healthcare space, supporting the case for more diversified exposure to the industry. Tax considerations aside, we’re generally positive on the transaction, particularly as it creates a more diversified biopharmaceutical firm with multiple leading franchises. AbbVie will be busy capturing deal synergies following closing.
<< View AbbVie’s product pipeline
Valuentum’s Take
Many holdings in the Health Care Select SPDR ETF have solid product pipelines, and while a few are still working through their respective patent cliffs, mid- and late-stage therapies across the sector are progressing well. Consolidation in the industry is also ramping, and with historically-low interest rates, we would expect more deals to surface soon. We think one of the best ways to gain exposure to both positive trends (pipeline progression and consolidation) is via the Health Care Select SPDR ETF. Recent quarterly performance supports such a position.
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Biotechnology: ALXN, AMGN, BIIB, BMRN, CELG, GILD, QCOR, REGN, TECH