Cover Story

25 top health care stocks: Will they lead the next market boom?

Breakthrough technology and discoveries will propel the sector upward for years. Here are the experts' picks to get you in on the action.

By Leslie Kane
Senior Editor

Biotechnology has revolutionized drug development and pushed medical stocks into a growth sprint that will likely become a marathon. Just look at 2000, a year when the bull market ended for most sectors: Though the Standard and Poor's 500 Stock Index lost 10.2 percent and the Nasdaq plummeted a heart-stopping 39.3 percent, medical stocks gained 26.9 percent.

"Biotech companies are where computer-chip manufacturers were five years ago," says Dallas investment adviser Joe Duarte. "Continuing progress will make the health care sector the fastest growing and most profitable of the decade."

Emerging markets will help boost the sector, says Michael Yellen, a portfolio manager for the AIM Global Health Care Fund. "As worldwide standards of living increase, health care spending in less-developed countries will pick up."

The health care sector consists of four segments:

Biotechnology. "Companies in this segment discover and develop proteins, antibodies, and small molecules for potential drug treatments," says Alidad Mireskandari, who manages the Monument Medical Sciences Fund. "Biotech companies have over 300 compounds in human clinical trials, and as these products are approved in the next few years, more and more are going to become profitable." In addition, the time required to create and test a drug will go from the current 10 to 15 years to under two years; the failure rate will drop to less than 20 percent.

Duarte adds, "In general, the biotechs are better investments than the human genome concerns [which create strings of genomes to study]. Many of the genomics companies have a concept, but no profits. Many biotech companies have already turned a gene product into a tangible compound."

Pharmaceuticals. "Traditional pharmaceutical companies will do well in the next decade," says Mireskandari. "Most large drug companies have formed joint ventures or affiliations with biotech firms, to tap their capabilities. Demographics will also play a role. Aging baby boomers will increase the demand for medicines and treatments."

Recent drug-firm mergers have given the resulting companies sweeping product lines and a global reach. Big pharmaceuticals will still do well marketing in parts of the world where biotechs don't sell. "The lion's share of new products will be from biotech," says John McCamant, editor of the Medical Technology Stock Letter. "I predict that in five years, more than 50 percent of new drugs will come from biotech."

Services. Insurers, hospitals, managed care companies, and ancillary services will be profitable in the coming year, says Yellen. "While HMO stocks may lag this year," he adds, "I'm very positive on hospital stocks; I think they will outperform every other health care sector in 2001."

Some reasons for the rosy outlook: HMOs have implemented tiered drug benefit programs, in which consumers pay more for brand-name drugs than generics. Many insurers have upped premiums and improved profits. The draconian legislative environment has eased, and in December, Congress approved legislation to return about $35 billion in Medicare funding to health care providers and insurers.

Medical supplies. This category includes devices that are implanted in patients, used to monitor and diagnose conditions, or used to discover and test new drugs and gene products.

"As the number of elderly increases, we'll see more knee and joint replacements and more operations using new implements," says John R. Borzilleri, a portfolio manager for the State Street Research Health Sciences Fund. "Companies are also developing external devices to replace invasive procedures. HMOs favor these less-costly treatments, which means their usage will increase."

To point you to the best health care stocks for the coming decade, we asked Borzilleri and the other four experts already quoted in this article to give us their picks. (See below for details on their credentials.) They looked for companies that use innovative science or proprietary technology, offer products or services with a competitive advantage, have strong drug candidates in the pipeline, and have sound financial underpinnings. Each stock was named by at least one—often, more than one—of our investment gurus. Here are their choices:

Accredo Health is making itself the FedEx for costly biopharmaceuticals that require specialized handling. "Biotech drugs are used in minute quantities and can't be mass distributed," says Duarte. "Accredo Health is building the relationships and the system to be the leading biotech pharmacy distribution service." It has secured long-term, preferred relationships with Biogen, Genentech, and Genzyme, three top biotech companies.

Accredo Health offers overnight delivery, clinical support, and data tracking for drug treatment of multiple sclerosis, Crohn's disease, rheumatoid arthritis, and other chronic ailments. It ships most medications in refrigerated containers to patients' homes or physicians' offices, where the drugs are reconstituted.

Amgen is a global biotech company with a track record that lifts it way above the new biotech wannabes. "Amgen has a good reputation for research and marketing, and well-accepted, profitable products," says Mireskandari. Those products include the blockbuster drug Epogen, which treats anemia in dialysis patients. In January, Amgen won a major legal battle to protect its patent on Epogen, so it still has that market to itself.

The company's other lead products include Neupogen, which helps the body fight infection during chemotherapy; Infergen, which combats chronic hepatitis C; and Stemgen, which supports stem cell transplants. Sales of these four products totaled $3.3 billion in fiscal year 1999. Amgen is developing a next-generation Epogen, as well as new drugs for rheumatoid arthritis and prostate cancer.

Applied Biosystems, formerly PE Biosystems Group, develops and markets instruments, reagents, and software. Its products are used for biotech and pharmaceutical research and development, as well as in diagnostics and food testing. AB products raked in sales of $1.2 billion in fiscal year 1999, and more than 30,000 laboratories in over 100 countries use them.

Using Applied Biosystems equipment, a German scientist took only two months to locate and identify a gene responsible for a form of hypertension. Without such equipment, researchers required 10 years to localize the Huntington's disease gene.

Aradigm aims to reduce the need for injections by creating inhalable drugs. It's developing aerosol versions of insulin, narcotic analgesics for chronic pain, and a drug for treating cystic fibrosis.

"The market potential is enormous, " Mireskandari says. "One reason I favor Aradigm is that it will have access to all the insulin it needs, through its collaboration with Novo-Nordisk. Other inhalable drug developers may be ahead in clinical trials, but they have to rely on less proven suppliers."

ArQule designs and synthesizes molecules that have the potential to become new drugs, which speeds up the drug discovery process.

"ArQule's system solves one of the biggest problems in coming up with genes to turn into drugs," says Borzilleri. "The traditional process involves random screening. ArQule eliminates trial and error, and zeroes in on strategic targets."

The company is collaborating with GlaxoSmithKline and Acadia Pharmaceuticals, which has developed more than 200 genomic drug markers.

Biomet designs and manufactures reconstructive and orthopedic support devices, electrical bone-growth stimulators, and operating room supplies. "Biomet has made a major advance by using metal instead of plastic as a base for replacement hips," says Mireskandari. "The wear rate on the metal is 10 to 100 times less than that of plastic."

In addition, Biomet has launched a new implant for osteoarthritis, as well as an implant procedure that's less invasive than total knee replacement. And last year, Biomet bought Biolectron, whose orthopedic products include a noninvasive spinal stimulator for use on an outpatient basis. Previously, Biomet lost those sales to competitors.

CardioDynamics International manufactures noninvasive monitoring devices that improve disease management and treatment. Its chief products, the BioZ Systems, are noninvasive hemodynamic monitors that can be used for patients with high blood pressure, congestive heart failure, diabetes, high-risk pregnancy, and kidney dysfunction.

"CardioDynamics' new heart-monitoring device provides data on a wide range of hemodynamic parameters that are typically available only through pulmonary artery catheterization," says Mireskandari. "It's safer for patients, and HMOs love replacing surgery with noninvasive procedures."

It's also more economical: Using a BioZ System typically costs the hospital just $47 per patient, compared with more than $1,000 for pulmonary artery catheterization.

Chiron, a 20-year-old biotech company, is one of the sector's bluebloods. In the 1980s, Chiron discovered and cloned hepatitis B antigens, used to develop the first genetically engineered vaccine. About the same time, Chiron cloned and sequenced the entire HIV genome, enabling scientists to study the disease's structure.

Today, the company's key products prevent and treat kidney cancer, metastatic melanoma, multiple sclerosis, and infectious and cardiovascular diseases. Chiron also develops vaccines and blood tests used by the blood banking and plasma industry.

"Chiron's products are well-received," McCamant says. "The company is strong on innovative research and development, and it has consistently positive revenues." That's partly due to royalties from diagnostic technology for hepatitis C, AIDS, and other diseases, which now total $30 million or more a year.

Cigna has the best aggregate health care margins in the industry, and the company's earnings have met or exceeded analysts' estimates for 29 of the last 30 quarters.

Why is Cigna so healthy? For one thing, it has limited exposure to medical cost inflation: Only 20 percent of its insureds are in programs that pay full reimbursement. Also, the company is diverse. "Managed care and health insurance comprise just part of its operation," says Duarte. "Once Cigna gets in the door with health insurance, its reps offer deals on disability insurance, pension plan management, mutual funds, and life insurance. This keeps Cigna insulated from the ups and downs of the health insurance sector."

The company and its subsidiaries provide employee health care services, group life, accident and disability insurance, discount brokerage, and other financial and investment products and services.

Cor Therapeutics develops and sells drugs that treat and prevent severe cardiovascular disease. It focuses on unstable angina and acute myocardial infarction.

The 13-year-old company's leading product, Integrilin, prevents blood clots. Moreover, recent studies showed that the drug can help reduce the likelihood of heart attack or death in the short term. In 2000, Integrilin became the most used drug of its type in the US. This year, Schering-Plough and Genentech announced plans to copromote Integrilin with some of their own products.

Genentech is one of the nation's leading and most progressive biotechnology companies. It holds more than 3,600 patents worldwide, with about 2,600 others pending. Its drugs treat cancer, cardiovascular disease, and growth hormone deficiency, and help manage cystic fibrosis. Important products include TNKase, a clot-busting agent that helps prevent heart attacks, and Herceptin, used to treat metastatic breast cancer.

Genentech was the first biotech company to manufacture protein in quantities large enough to test and market. Previously, scientists eked out minute quantities for research. The company's biotechnology research facility and multi-product biotechnology manufacturing facility are the largest in the world.

"Genentech's research and development is phenomenal," says Mireskandari. In fiscal year 1999, the company put approximately 26 percent of its $1.4 billion revenues into research and development, far more than the pharmaceutical industry average.

Genzyme (General Division) is a leading biotech business with nearly 600 products and services already on the market and a solid, profitable revenue base. Genzyme focuses on therapeutic and diagnostic uses. Its pharmaceuticals, biotherapeutics (including treatments for cystic fibrosis), cholesterol testing products, and genetic testing services do particularly well.

Genzyme is ready to launch at least five therapies for genetic disorders. Potential products include treatments for cystic fibrosis and prevention of blood clots.

"Genzyme already has a leading product for osteoarthritis, and more are underway," says Duarte.

Eli Lilly develops and markets pharmaceuticals and animal health products in more than 120 countries. Lead products include Zyprexa, for schizophrenia; Darvon, for pain; Axid, an anti-ulcer medication; Humulin, a form of human insulin; and Evista, for osteoporosis.

In August 2001, Lilly will lose its patent protection on Prozac, and generic competitors will drain some market share and profits. Still, Lilly has potential blockbuster drugs in the pipeline, including Zovant, for sepsis; Duloxetine, for depression; and Tomoxetine, for attention-deficit disorder.

Human Genome Sciences is one of the foremost companies to shift from a gene-sequencing to a product-development focus. Its scientists built a collection of partial human gene sequences, allowing them to develop novel compounds that use the body's own genes, proteins, and antibodies. It holds 162 patents and has filed patent applications for 10,000 other gene-based products.

The company's lead drug in human clinical trials is Repifermin, which may help heal venous ulcers and injured mucosal tissue in the gastrointestinal tract. Damaged mucosal tissue often prevents chemotherapy patients from absorbing nutrition.

The company got a recent boost when Schering-Plough exercised its option to develop and commercialize a protein identified by Human Genome Sciences. The protein could be used to treat autoimmune diseases and cancer.

ICN Pharmaceuticals makes and sells nutritional and pharmaceutical products that treat viral and bacterial infections, skin diseases, neuromuscular disorders, cancer, heart disease, diabetes, and psychiatric disorders. Its leading anti-viral agent, Virazole, is approved in 43 countries to combat diseases including flu, herpes, and HIV.

Royalties for Rebetron, an anti-viral drug used to treat hepatitis patients, were expected to reach $160 million last year. An estimated 2 percent of the world's population is infected with hepatitis C.

The company is introducing a more efficient version of the drug, and it plans to start selling Rebetron in Japan.

Icos aims to develop drugs that can be used to treat serious medical conditions, such as pulmonary hypertension and sepsis. The company is also testing a drug that may give Viagra a run for its money: Cialis, which would treat male and female sexual dysfunction, has had promising results in clinical trials. It's being developed as part of a collaboration with Eli Lilly. "Cialis is a potential billion-dollar drug and has shown fewer side effects than Viagra," says McCamant. Other compounds in trial treat sepsis and acute respiratory distress syndrome.

"Icos also has partnerships and joint ventures with Suntory, a Japanese company, and other US firms, which will enable it to develop and market drugs more effectively," says McCamant.

ImClone Systems, a biopharmaceutical company, develops cancer treatments and agents that retard tumor growth. Its lead product, still in clinical development, blocks the signal that allows tumor cells to grow and divide. A potential breakthrough drug for colorectal cancer is also in the works. "If it pans out, ImClone Systems will be the first to market with an effective treatment. It could be extremely profitable," says McCamant.

ImClone Systems also develops diagnostic products and vaccines for infectious diseases and leases those rights to Abbott Laboratories, American Home Products, and other corporate partners.

Johnson & Johnson, best known for consumer products such as Tylenol and Johnson's Baby Shampoo, does a larger business with pharmaceuticals and products used by doctors and hospitals. Its biggest selling drug is Procrit, which fights anemia and brings in annual sales of more than $2 billion.

"Buying J&J is like buying a mutual fund," says Duarte. "You get everything from Band-Aids to the highest degree of medical technology, through subsidiaries such as Ethicon Endosurgery and Cordis."

New products promise continued growth. J&J recently introduced a new coronary stent that captured 20 percent of its market within months; high-margin blood glucose monitors; and Benecol Spread, a butter substitute that can lower cholesterol.

Medtronic, the world's leading medical technology company, develops products that treat and manage coronary and peripheral vascular disease, pain, and spinal problems. It's also the leading supplier of pacemakers and defibrillators as well as cardiac, neurological, and spinal surgery products.

Medtronic is zealous about research and development. For each device it sells, its scientists are already planning four generations of upgrades and longer-term technologies.

Merck, the worldwide pharmaceutical company, makes Pepcid, Propecia, and a roster of other human and animal health products. The Merck-Medco Managed Care Division manages pharmacy benefits for more than 50 million Americans. Merckmedco.com, the world's largest Internet pharmacy, reports new online prescription sales that are growing by more than 30 percent per quarter.

Merck has many blockbusters: Vioxx is the world's fastest-growing prescription arthritis medicine, and Fosamax is the leading medicine for the treatment of postmenopausal osteoporosis. Other strong performers include Zocor, which improves cholesterol levels; Singulair, for asthma control; and Cozaar and Hyzaar, both for high blood pressure. To jumpstart new product sales, Merck will hire 1,500 additional sales reps by the end of next year.

Myriad Genetics is speculative, "but it has excellent growth prospects," says Yellen. The company has patented technologies to discover novel genes and their proteins, therapeutic drugs, and diagnostic products. It also has established collaborations with seven major pharmaceutical companies.

The 10-year-old firm has developed new diagnostic tests for colon and endometrial cancer, and other tests are gaining wider acceptance. Myriad Genetics' ProNet is one of only two commercial technologies chosen by a consortium of 50 scientists in a major experiment to discover how cells interact during disease processes.

Pfizer is aggressive and has done a fine job of building a robust drug pipeline, says Mireskandari. The company became the world's largest pharmaceutical firm after last year's merger with Warner-Lambert. Its brands include Viagra, Zoloft, Benadryl, and Listerine. For 2000, revenues were expected to reach $32 billion. Fifteen of its products generate annual sales exceeding $500 million apiece.

The company markets pharmaceutical, animal, and consumer health products in more than 150 countries. Its research and development budget is the highest in the pharmaceutical industry.

Pharmacia, created by last year's merger of Pharmacia and Upjohn with Monsanto, is a leader in arthritis and inflammation treatments, antibiotics, oncology, and ophthalmology. Its top products include the arthritis pain drug Celebrex; Xalatan, the world's best-selling brand of therapy for glaucoma; and Rogaine. "Pharmacia has a deep product line that serves unmet needs," says Mireskandari.

The company is planning to divest its agricultural biotech business for about $1 billion, which it can use to pay off debt and boost its bottom line. The FDA recently approved its once-daily drug for overactive bladder, and Pharmacia has a ready market: About 17 million Americans suffer from the condition.

St. Jude Medical is the world leader in heart-valve disease management products, including replacement heart valves, cardiac rhythm management systems, and other cardiovascular devices.

This year, St. Jude Medical launched its first dual-chamber implantable cardioverter defibrillator, and it's mobilizing its sales force to tap the $1 billion annual market for that device. The company already has a strong position in the single-chamber ICD market.

St. Jude Medical will also release a line of revolutionary sutureless devices for coronary artery bypass graft surgery, providing a new approach to a critical part of the bypass procedure.

Waters is the world leader in high-performance liquid chromatography (HPLC) instruments and technology. HPLC is a technique for isolating, separating, and quantifying compounds in complex mixtures. Most pharmaceutical assays used in drug development and commercialization are HPLC-based.

The increasingly important study of protein structure, now used in the development of new pharmaceuticals, will also benefit Waters, since the company's mass spectrometry products play a critical role in identifying human protein properties.

Best health care stocks

All data as of March 13, 2001. Stocks with four-letter tickers trade on Nasdaq. All others trade on New York Stock Exchange.
N.A.: Not available, because the company has no earnings or its P-E ratio is too high to be meaningful.

Source: Dow Jones

For our experts' views on these companies, see below.

What the experts think about these companies

The experts who picked our stocks

John R. Borzilleri, a nonpracticing physician who also holds an MBA, is a portfolio manager for the State Street Research Health Sciences Fund, in Boston. He was formerly an equity analyst at Montgomery Securities and Dean Witter.

Joe Duarte, a part-time anesthesiologist and the author of Successful Biotech Investing, is president of River Willow Capital Management, an investment advisory firm in Dallas.

John McCamant edits the Medical Technology Stock Letter in Berkeley, CA. Hulbert's Financial Digest, an independent tracker of investment newsletters, ranked McCamant's publication among the top five performers over the past five and 15 years.

Alidad Mireskandari, a portfolio manager for the Monument Medical Sciences Fund in Bethesda, MD, has a PhD in genetics and an MBA. He has consulted on technology development in the pharmaceutical and medical devices industry, and did research at the National Institutes of Health National Cancer Institute.

Michael Yellen, a portfolio manager for the AIM Global Health Care Fund in Houston, has been a manager for such AIM mutual funds as Global Resources, and Global Consumer Products & Services.

 

Leslie Kane. 25 top health care stocks: Will they lead the next market boom?. Medical Economics 2001;7:126.