Issue #36: A pioneer in value-based medicine and a pharmaceutical powerhouse trading at a very appealing valuation 🚨
Jean Hynes joined Wellington Management in 1991 as an administrative assistant. In 2013 she took over management of Wellington’s $51.7 billion Vanguard Health Fund, the largest healthcare fund in the country.
In July 2021 Hynes took over as Wellington’s CEO, putting her in charge of over $1 trillion in assets.
Hynes sees healthcare as one of the great growth stories of the near future, driven by three trends:
- Aging populations in developed economies.
- Rising middle classes in emerging markets.
- The surging pace of biomedical innovation.
The challenge of healthcare investing is to identify companies sitting at the intersection of those trends.
That lesson can be applied to other sectors as well. Growth is almost always driven by multiple factors. The investor’s job is to find companies that are riding on multiple growth trends simultaneously.
Let's get into this week’s report.
- A major pharmaceutical manufacturer offering a solid valuation on an overreaction to bad news.
- A new player shaking up the healthcare industry with a combination of data analytics and home-based service.
AbbVie, Inc. ($ABBV)
$107.07 - Share price at time of writing
- AbbVie Inc. develops and manufactures a wide range of pharmaceutical products.
- AbbVie has a strong product presence in cancer treatment and immunology drugs, including rheumatoid arthritis therapies.
- In May 2020 AbbVie acquired Allergan, gaining a portfolio of aesthetic medications (including Botox), eye medications, and neurological drugs.
- AbbVie is a dividend aristocrat that currently offers a 5.86% dividend yield.
What they do:
AbbVie is a global biopharmaceutical company engaged in the development, manufacturing, and sale of innovative medicines and therapies. AbbVie was spun off by Abbott Laboratories in 2013.
AbbVie products include the following:
- Humira is used to treat autoimmune diseases, including arthritis, ulcerative colitis, Crohn’s Disease, and others. Humira accounted for 43% of revenues in 2020.
- Skyrizi is a treatment for moderate to severe psoriasis.
- Rinvoq is used to treat rheumatoid arthritis, psoriatic arthritis, and other autoimmune disorders.
- Imbruvica is used to treat a range of hematologic cancers, including forms of lymphoma and leukemia, and is used for chronic graft vs host conditions.
- Venclexta is used to treat several hematologic cancers.
The Allergan acquisition brought several new products into the AbbVie portfolio, including:
- Aesthetics products, including Botox, Juvederm dermal fillers, and a number of other products.
- Neuroscience products, including treatments for schizophrenia, depression, bipolar disorder, Parkinson’s Disease, and migraine.
- Eye Care Products, including treatments for glaucoma, ocular hypertension, and other conditions.
- Women’s Health Products, including oral and intrauterine contraceptives, and treatments for endometriosis, and others.
Other AbbVie products are used to treat hypothyroidism, irritable bowel syndrome, pancreatic insufficiency, to provide palliative care to advanced prostate cancer patients, and many others.
AbbVie has a robust development pipeline. There are 23 drugs currently in stage III clinical trials, including treatments for Parkinson’s Disease, Breast Cancer, Ovarian Cancer, and others. Atogepant, a new therapy for migraine prophylaxis, has completed phase III trials and has been submitted to the FDA for approval.
What we learned from social media patterns:
Social media mentions of $ABBV soared in the first week of September.
The interest was clearly driven by the FDA’s announcement that JAK inhibitors, a class of drugs that includes AbbVie’s Rinvoq, would have to carry a warning stating that they may increase the likelihood of cancer and cardiac events.
The announcement completely overshadowed a piece of good news: a court victory that affirmed the company’s patents on the Imbruvica cancer drug until 2032, protecting $5 billion in annual revenue.
There are significant concerns over the prospect of patent protection for Humira, the company’s best-selling product, losing patent protection starting in 2023, but that has been priced in for some time.
Notable comments from Reddit:
“I love ABBV long term and bought more after being oversold. Also bought some cheap Jan 21, 2022 110c
Think the selling was a huge overreaction and thinking it will bounce back in Q4. Definitely a long term hold”
“The drug in question, Rinvoq, already has all of these in its prescribing information except cardiac events... Which means it is going to have minimal or no impact on sales whatsoever. Rinvoq is dominating the Rheumatoid arthritis (its only indication so far) market space and kicking the shit out of its competitors within the drug class”
💸 Signal: Warren Buffet, the king of traditional value investing, holds $2.2 billion in $ABBV. Cathie Wood, the queen of 21st century innovation investing, holds $58.5 million. It’s unusual for a stock to make an impression on both.
Why $ABBV could be valuable:
The global pharmaceutical industry is expected to grow at a CAGR of 11.34% through 2028.
One of the primary drivers of industry growth is the aging population. $ABBV products in cancer treatment, autoimmune diseases, arthritis, and aesthetic medicine are well positioned to exploit this trend.
$ABBV has experienced sell offs from two major concerns: hazard labeling on Rinvoq and the prospect of competition for Humira starting in 2023. Both concerns may be overrated.
Developing and manufacturing biologic therapies like Humira is expensive and requires significant investment, which will restrict competition. Only a biosimilar product that is proven to be fully interchangeable will be considered substitutable by the FDA, and that is difficult to achieve.
The hazard warnings on Rinvoq were largely already included in product information and it has yet to be seen how they will affect sales.
$ABBV has a robust pipeline of new drugs ready to replace products as they eventually go off patent.
AbbVie is a dividend aristocrat: it has raised its dividend every year for 25 consecutive years. After the recent sell off the dividend yield suits at an exceptional 4.86%. Any drop in the stock price will raise that yield even higher, drawing in income investors and supporting the stock price.
Some investors have been put off by the 134.05% payout ratio, which indicates that the dividend is unsustainable. This figure is based on 2020 earnings, which were reduced by costs associated with the Allergan acquisition.
2020 diluted EPS was $2.62, down from $5.28 in 2019. 2021 diluted EPS is expected to be $12.52-$12.62, reflecting the full impact of the acquisition. This would be a 388% jump in earnings. Assessed on TTM earnings rather than 2020 earnings, the payout ratio drops to 44%, which is entirely sustainable. That makes the dividend extremely appealing.
$ABBV has beaten analyst consensus earnings estimates for 4 consecutive quarters. The operating margin is 35.17% and ROE is 48.86%, both outstanding. Revenue growth was flat from 2018 to 2019 but increased dramatically in 2020 and is on track for an even greater increase in 2021.
$ABBV is trading at 8.4 times forward earnings, against 14.5 for the pharmaceutical industry as a whole, a sign that it could be significantly undervalued.
20 analysts cover $ABBV. The consensus rating is “Buy” and the average price target is $127.01, 18% above current levels.
What the risks are:
The expiration or loss of patent protection could create significant competition for some of AbbVie’s top selling drugs, reducing sales and earnings. Third parties or government agencies could seek to challenge AbbVie’s patents.
One product - Humira - accounted for 43% of revenues in 2020. Any adverse event related to this product could have an impact on the Company’s results.
AbbVie relies on a continuing stream of new products. There is no assurance that the products currently in clinical trials will successfully complete the trials or win FDA approval.
AbbVie operates in highly regulated markets all over the world, and has to spend significant effort to comply with multiple regulatory regimes. Any compliance failure could disrupt AbbVie’s business.
AbbVie is in the process of integrating Allergan, a major acquisition. If the integration is unsuccessful or requires unexpected time and expense, results could be affected.
Bottom line: AbbVie is an established company in a high-growth recession-proof industry. It’s showing strong revenue and earnings growth and good margins. The dividend yield is impressive while being sustainable. AbbVie offers a combination of growth, value, and defensive investing features.
Signify Health Inc. ($SGFY)
$19.85 - Share price at time of writing
- Signify Health works with insurers, employers, providers, and patients to provide more cost-effective patient-focused healthcare.
- Signify combines advanced analytics and extensive data with in-home visits and social/behavioral analysis to support home-based care and reduce hospital visits.
- $SGFY is on the leading edge of value-based healthcare, which bases rewards on positive outcomes rather than services provided.
- $SGFY shares rocketed to almost $40 following the Feb. 2021 IPO and have gradually dropped to the current level of under $20.
What they do:
Signify Healthcare is focused on reducing healthcare costs. They accomplish this in three ways:
- Home-based care allows providers to prevent health issues or treat them early, avoiding expensive hospitalizations.
- When patients are hospitalized, Signify puts useful data at the fingers of providers and payers, allowing efficient care and fair billing.
- When patients are discharged from hospitals Signify provides home-based continuing care to prevent expensive readmissions.
Signify’s clients are government programs like Medicare Advantage, Managed Medicaid, state health agencies, Accountable Care Organizations, private insurers, and employers.
Signify works in several service categories.
- In-Home Evaluations and Related Services operates the largest mobile network of credentialed providers in the US. They perform physical and virtual in-home assessments along with in-home diagnostic services.
- Biopharmaceutical Services are coordinated with home-based care, allowing supervised use of complex therapies at home and helping companies like Bristol Myers Squibb ($BMY) and Novartis ($NVS) to identify volunteers and collect data for clinical trials.
- The Episodes of Care Services segment supports the organization and financing of hospital care to improve outcomes and reduce costs. Signify’s data analytics capacity provides clinicians with the information they need to improve treatment and gives managers data on fair benchmark pricing.
- The Transition to Home service works with over 50 hospitals in 12 states to provide patients transitioning to home care with support from social care coordinators, nurses, and nurse practitioners. The system monitors patient progress, identifies problems, and helps avoid readmission.
Signify’s revenues come from several sources:
- Administrative service fees and a share of savings generated by the Episodes of Care segment.
- Compensation from health plans for IHEs and Virtual IHEs.
- Compensation from health plans, health systems, government agencies and pharmaceutical companies for management of post-acute care, social determinants of health analysis, care management, caregiver support and other services.
Most revenues are sourced from long-term multi-year contracts.
What we learn from social media discussion:
There is virtually no discussion of Signify Health on social media.
The absence of retail investor interest is not easy to explain. $SGFY is not profitable, but that’s not unusual in a rapidly expanding post-IPO company. Revenue and EBITDA growth are exceptional and healthcare is a rapidly growing industry with huge prospects.
Widely followed growth investor Cathie Wood has been accumulating $SGFY shares. That usually grabs investor attention, but in this case, it has not.
We can’t fully explain this phenomenon, but we can observe it: for whatever reason, Signify Health has not caught the attention of the retail investment community.
According to NASDAQ, roughly 58% of the company is still owned by private equity firms that invested before the IPO and another 19.6% is held by other institutions.
💸 Signal: Cathie Wood’s Ark Innovation ETF purchased 1.69 million shares of $SGFY in Q1 2021 and added 2.32 million shares in Q2.
Why Signify Health could be valuable:
Signify Health sits at the interface of several growth trends.
- US Healthcare spending is expected to reach a CAGR of 5.4% through 2028.
- The healthcare analytics market is expected to grow at a CAGR of 23.8% through 2028.
- The home healthcare market is expected to grow at a CAGR of 7.88% through 2088.
The aging US population is forcing an inevitable rise in healthcare spending. Signify’s home-based health systems are ideally positioned to provide preventive and supportive care to older Americans.
Rapidly rising healthcare costs and health insurance costs have driven a surge of interest in preventive care, primary care, home-based care, and other ways to reduce costs and improve outcomes at the same time. Keeping patients out of hospitals is a rising priority across the healthcare spectrum.
Signify’s advanced algorithms for data capture and analytics reduce the cost and increase the accuracy of critical health information processes that serve as the basis for clinical and care planning decisions.
Signify Health’s customer list is extensive: Aetna ($AET), UnitedHealth Group ($UNH), Oak Street Health ($OSH), Ascension Health, Oscar Health ($OSCR), Geisinger Health, Anthem ($ANTM), Humana (HUM), and many others. All of them have an overwhelming incentive to improve efficiency and reduce or prevent healthcare costs.
Signify Health’s most recent quarterly results indicate surging adoption of its products. Q2 2021 revenue was up 63% from Q2 2020, driven by a 109% increase in Home & Community Services revenue. The Company raised revenue guidance for FY 2021 from a range of $725 to $760 million to a range of $745 to $765 million.
Analysts expect $SGFY to achieve profitability by early 2022.
$SGFY currently trades at 4.5x TTM sales, below the Healthcare Information & Technology sector average of 6.78. The Company’s revenue growth rate is well above sector averages. Among immediate competitors, Accolade ($ACCD) trades at 14.67x TTM sales and 1Life Healthcare ($ONEM) trades at 8.94 x TTM sales.
8 analysts cover $SGFY, with a consensus “Buy” recommendation (3 Strong Buy, 4 Buy, 1 Hold). The average price target is $31.75, 60% above current levels.
$SGFY stock is in a common pattern: a rapid surge after the IPO followed by a gradual decline. The stock is now below its IPO price despite consistent revenue growth and projected profitability.
What the risks are:
Signify Health has a history of losses and may not achieve profitability. Current revenue growth rates may not be sustainable.
Much of Signify’s revenue comes from plans managed under federal programs, mainly BPCI-A. Changes in Medicare or Medicaid rules could have a significant impact on operations.
Operations, mainly in the Episodes of Care segment, have been negatively affected by the COVID-19 pandemic. If the pandemic continues or accelerates that impact could increase.
Healthcare is an intensely competitive business and Signify will have to innovate constantly to maintain and improve its competitive position.
A large percentage of $SGFY stock is owned by venture capital investors. If these investors choose to liquidate their holdings the value of the stock could be adversely affected.
Bottom line: Signify Health sits at the intersection of several compelling growth trends in the healthcare industry. It’s a new company, which creates risk, but that also provides a low entry point to an enterprise with long-term potential.