In the third quarter, however, according to his GuruFolio, his most-bought sector was health care, which was also the third best performer this year, gaining 16% through November. Yacktman increased his portfolio’s weighting in this sector to 17.5%, from 16.6% the previous quarter, his highest weighting since the fourth quarter of 2010. Within this sector, he was able to identify two stocks that remained undervalued and overlooked by the market: Stryker Corp. (SYK) and Wellpoint Inc. (WLP).
The health care industry overall currently has an average P/E ratio (ttm) of 18.2x, a P/S (ttm) of 1.2x and a dividend yield of 1.86%. Earnings for the sector exceeded analysts’ expectations for the 12th consecutive quarter in the first quarter of 2012.
Because health care stocks tend to resist market upheavals since demand for health care changes little, they are often considered defensive stocks for uncertain times. “During the past two decades—through various economic cycles, financial crises, and housing and tech bubbles—health care has been one of the most stable, consistent-performing sectors in the marketplace. There is little reason to expect that will change.” https://www.fidelity.com/viewpoints/state-of-healthcare-sectors
Though President Obama’s individual mandate was upheld by the Supreme Court in June, Fidelity Investments portfolio manager Eddie Yoon, writing just before the decision, foresaw this outcome from a favorable decision: “If the individual mandate is deemed to be constitutional, health insurers will likely benefit from an increase in enrollment, and others in the supply chain could see increased utilization of health care products and services,” he said in a June Fidelity Viewpoints memo titled "State of the Sector: Health Care."
Yacktman owns more than 9.7 million shares of Stryker Corp., after increasing the stake by almost 74%, or 4,132,301 shares, in the third quarter. He bought the stock in the second quarter of 2009, but the third quarter marked his largest purchase and largest holding yet of the company.
Stryker is a medical technology company that develops a variety of innovative medical technologies in the areas of reconstructive, medical and surgical, and neurotechnology and spine products. It helps healthcare professionals provide more efficient and enhanced patient care. CNN Money ranked it the world’s Most Admired Company in the medical equipment category for 2012.
Stryker Corp’s Tuesday opening stock price of $54.58 is essentially flat since the start of 2010, with little movement in the meantime. The company has shown solid operational performance, with the ability to increase revenue each year since 2002, and earnings at an average rate of 12.8% annually over the same period. Cash flow has been positive for a decade, and above $1 billion each year since 2008.
The company sells its products in over 100 countries, and derived 65.3% and 63.4% of its total revenues from the U.S. in the first nine months of 2012 and 2011, respectively. Also in the first nine months of 2012, higher shipments of instruments, reprocessed and remanufactured medical devices and neurotechnology pushed net sales up 3.7% year over year.
The company has been vague about the impact the June 28, 2012, U.S. Supreme Court decision to uphold the federal legislation to reform the U.S. healthcare system would have on its business. In its third quarter 2012 10-Q it stated:
“The legislation is far-reaching and is intended to expand access to health insurance coverage, improve quality and reduce costs over time. We expect the new law will have a significant impact upon various aspects of our business operations. However, it is unclear how the new law will impact patient access to new technologies or reimbursement rates under the Medicare program. In addition, the new law imposes a 2.3 percent excise tax on medical devices, scheduled to be implemented in 2013, that will apply to United States sales of a majority of our medical device products. We continue to assess the impact that federal healthcare reform will have on our business.”
Partially in preparation for the excise tax, the company is laying off 5% of its workforce, among other restructuring activities, beginning in 2011 and expected to be completed by year-end 2013. Total restructuring costs are expected to reach almost $200 million.
Stryker has a P/E ratio of 13.7, P/B ratio of 2.5 and P/S ratio of 2.5, which are each historically low.
SYK data by GuruFocus.com
Back in 2010, Yacktman commented in an interview on what originally drew him to Stryker and other similar stocks:
“A third group, which we haven’t spent much time on, is the medical device area, which we’ve put a fair bit of money into in the last year or two. The common theme there from Johnson & Johnson (JNJ) to CR Bard (BCR), to Becton, Dickinson (BDX) to Medtronic (MDT) to Stryker (SYK) is you have high-quality businesses that have suffered significant multiple compression and now sell at attractive prices,” he said.
Yacktman’s second most-purchased health care company in the third quarter was Wellpoint Inc. (WLP). He bought 3,518,467 shares for $59 each on average, equal to a 1.2% weighting in his portfolio. Yacktman had owned a smaller holding of the company before, starting in 2008, which he sold out in late 2010.
WellPoint is the second-biggest U.S. insurer. Through nationwide networks, it offers integrated health care plans and related services and specialty services such as life and disability insurance, dental, vision and behavior health benefit services, long-term care insurance and flexible spending accounts. IT is also an independent licensee of the Blue Cross and Blue Shield Association.
WellPoint’s stock has not moved significantly since opening near $62 per share in 2010; it opened for $56 per share on Tuesday after declining 18% over the past year.
WellPoint’s revenue had been increasing each year of the last decade until it fell from $65 billion in 2009 to $58.8 billion in 2010. It continued to grow in 2011, when it reached $60.7 billion. The company’s net income has also topped $2 billion each year since 2005, and has declined each year from 2009 to 2011. At $56.27 per share Tuesday, WellPoint is trading for less than book value of $66.95, after continuous book value growth since 2007.
In July 9, 2012, the quarter Yacktman entered into his WellPoint investment, the company acquired Amerigroup for approximately $4.9 billion. The deal merged two leading health benefit and managed care organizations, and expanded its Medicaid footprint to 19 states, which combined have nearly 60% of the nation’s total Medicaid enrollment. The acquisition places WellPoint near the forefront of the high-growth government-sponsored managed care marketplace.
The company explained the propitious nature of the timing of the acquisition in a July conference call:
“We recognize that the pure-play Medicaid managed care companies, including Amerigroup, are currently trading at a premium valuation relative to historical levels, which reflects the potential growth in the markets that they serve and the new markets that are emerging. As we've discussed in the past, many state governments are facing significant budget challenges as they strive to provide access to healthcare for their most underserved residents. We expect states to take varying approaches to address these challenges, which will lead to more managed care solutions and innovative programs to serve those who are eligible for both Medicare and Medicaid.”
The acquisition was funded by approximately $700 million of cash, and $4.2 billion in commercial paper and new debt issuance, bringing its debt to capital ratio near 39%, with the goal to reduce that to 35% in the following 18 to 24 months.
The company currently has a 7.5 P/E ratio, which has rarely been in double-digits in the last five years. It also has a 0.8 P/B ratio and 0.3 P/S ratio.
WLP data by GuruFocus.com
Investor Jeff Auxier, in an interview with GuruFocus, was impressed by the company’s free cash flow yield: “During the uncertainty surrounding the growth of government in healthcare, we were able to invest in WellPoint (WLP) which was sporting a 20% free cash flow yield,” he said.
In August 2012, the company’s CEO, Angela F. Braly, stepped down after investors called for her ouster due to its stagnant stock price in spite of spending billions in share buybacks, poor quarterly performance and other missteps. Leon Cooperman of Omega Advisors who owns more than 2 million shares of WellPoint told Bloomberg, ““There’s a universal view that the CEO is the wrong CEO to lead the business.” In the second quarter, the company forecast it would lose 900,000 members and cut its forecast for full-year 2012.
Two candidates for CEO have taken the lead in the search: Ron Williams, former Aetna Inc. CEO, and Jim Carlson, Amerigroup Corp., the Indiana Business Journal reports, though it has no official selection yet.
Yacktman has nine other health care companies in his third quarter portfolio. The largest are: C.R. Bard Inc. (BCR), Becton Dickinson & Co. (BDX), Patterson Companies Inc. (PDC) and Covidien Plc (COV).
See his complete equity portfolio here. Also check out the undervalued stocks, top growth companies and high yield stocks of Donald Yacktman.