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Three Value Plays in Healthcare

Jason Clark, value investing specialist and contributing editor to The Prudent Speculator, reviews a trio of diverse holdings in the healthcare sector — a pharmacy play, a biotech in the vaccine market and a medical equipment maker.

See also: MDU Resources and the Sum of the Parts

CVS Health (CVS) saw its shares rise after reporting Q2 results that beat consensus analyst estimates on both the top- and bottom-lines. The health care and pharmacy retails services provider said adjusted EPS came in at $2.40 (versus the $2.17 est.).

CVS generated revenue of $80.64 billion (versus the $76.48 billion est.). Revenue growth for the quarter hit 11% vs Q2 of 2021. The Retail business experienced strong performance with continued growth in same-store prescriptions and front-end sales. Part of this boost is likely coming from store optimizations, where CVS is retaining an impressive 70% of scripts.

The Health Care Benefits segment is also performing well, with trends largely stable across its broader book of business. Another bright spot is specialty pharmacy with revenue up 21% year-over-year.

The company also announced that it had generated $9 billion in operating cash flow so far this year and paid down $1.5 billion of additional long-term debt. Since CVS closed on its acquisition of Aetna (November 2018), the company has repaid a net $22.5 billion of long-term debt.

Management raised full-year 2022 guidance for a number of measures. Adjusted EPS is now forecast to be between $8.40 and $8.60 (prior was $8.20 to $8.40), while cash flow from operations is now likely to come in between $12.5 billion and $13.5 billion (versus the prior $12 billion to $13 billion).

Although the competitive landscape isn’t getting any less challenging and there seemingly is always a regulatory cloud in the operational sky, we think there is plenty of runway ahead to improve access to care using CVS’s integrated health care delivery model.

We also appreciate that scale benefits from the Aetna acquisition are starting to show through. While shares have had a solid total return over the last year, we continue to find them attractive as they trade for less than 12 times NTM adjusted earnings estimates and yield 2.2%. Our Target Price for CVS has been raised to $139.

Moderna (MRNA) saw its shares soar after the vaccine maker reported Q2 2022 results that blew away analyst expectations. The company earned $5.26 per share (vs. $4.54 est.) in the quarter and had revenue of $4.75 billion (vs. $4.02 billion est.). COVID-19 vaccine revenue was $4.53 billon, 19% better than the analyst consensus estimate.

MRNA repurchased 9 million shares in Q2, bringing the total bought back to 18 million since the inception of the buyback program in 2021. Moderna finished the quarter with $18.1 billion of cash on hand, lower than last quarter’s $19.3 billion figure due mostly to the $1.3 billion spent on share repurchases.

We continue to believe our position in MRNA is equal parts Health Care and Technology, with the company able to leverage its mRNA technology and massive cash war chest to tackle other viruses and illnesses. Even though the share price has soared recently, the stock is still off more than 25% this year, but it has rallied mightily from the $113 low on June 13.

While MRNA shares trade for just 7 times estimated 2022 earnings, the company will need to see other successes to replace declining COVID-vaccine revenue in the future. Of course, with COVID variants still part of the current landscape, we think there is plenty of business still to be had from new booster shots. Our Target Price for MRNA has been hiked to $276.

Adjusted for the spinoff of its spine and dental business, which took place in March, Zimmer Biomet (ZBH) reported core earnings of $1.82 per share in Q2 that beat analyst estimates by 10%, while the $1.78 billion revenue figure topped forecasts by nearly 4%.

The medical equipment maker attributed the solid results to a stronger-than-anticipated COVID recovery and growing procedure volume. Foreign currency adjustments, supply chain constraints and inflation are headwinds management expects to stick around, but new product innovation and procedure momentum should help ZBH overcome those challenges.

The expected currency headwinds are a bit of a downer and are difficult to avoid, especially since currency hedging techniques are inconsistent and expensive. Importantly, management expects underlying revenue to climb, as should earnings and margins. Wall Street analysts and our proprietary valuation model concur.

We appreciate ZBH’s hard work to rework its product suite with cutting edge technology like its ZBEdge ecosystem, a suite of integrated digital and robotic technologies, and the momentum built for its ROSA Robotics equipment.

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We continue to like Zimmer’s global revenue stream (even if gets knocked in the near term by accounting rules) and expect to see benefits from the company’s new product lines. Our Target Price has been adjusted to $169.

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