Health Care Standouts :
 Drugs and More

Besides Regeneron (NASDAQ: REGN) (p.4), Growth Portfolio offers four more ways to dive into health care.

Eli Lilly (NYSE: LLY) is our favorite big pharma stock, with a diversified portfolio of more than two dozen drugs, none accounting for more than 13% of sales. 
On a trailing 12-month basis, revenues topped $22 billion and per-share earnings were more than $3.50. Six drugs, led by diabetes treatments Humalog and Trulicity, generate annual sales of at least $1 billion.

Humalog, taken at mealtime to keep blood sugar low, has been around since the 1990s and was the first insulin analog to enter the market. Trulicity, introduced in late 2014, stimulates the body to release insulin. Its sales are expected to climb 33 percent in 2018, to $2.6 billion. Trulicity also is being tested to treat heart disease, with data expected in 2018.

Lilly has been deft at replacing drugs facing patent expiration. Five of its blockbusters – annual sales of $1 billion or more – are mature drugs: Humalog, Alimta (lung cancer), Forteo (osteoporosis), Humulin (synthesized insulin), and Cialis (erectile dysfunction). 
Lilly sales dipped a few years back after its star drug, antidepressant Cymbalta, lost exclusivity. But although Cymbalta revenues dropped from above $5 billion in 2013 to about $730 million in 2017, Lilly’s overall 2017 revenue will be just $500 million below 2013’s level as new drugs picked up the slack.
Five Lilly drugs launched in 2014 or later should surpass $1 billion a year in sales in the next few years. Besides Trulicity, they are Jardiance (shown to reduce heart attacks and strokes in diabetes patients), Taltz (plaque psoriasis), Basaglar (insulin), and Cyramza (certain gastric and lung cancers).

Lilly will soon launch recently approved breast cancer oral pill Verzenio. Unlike competing drugs, it can be taken either on its own or in combination with other medications, and on a continuous rather than cyclical schedule. Lilly also has just applied to the FDA to review galcandezumab (migraine headaches). Earlier in 2017 it resubmitted an application for Olumiant (rheumatoid arthritis). The company has more than 15 ongoing phase 3 clinical studies, a dozen in phase 2, and many more in phase 1.

Lilly may sell or spin off its relatively low-margined animal health division Elanco, likely resulting in a special dividend for shareholders and improving overall profit margins.

Biogen’s (NASDAQ: BIIB) portfolio is more concentrated, and its top four drugs account for 90% of product sales. But its muscular sclerosis (MS) franchise is the best in the business. 
Tecfidera, launched in 2013, is the world’s top-selling MS oral pill, with $4 billion-plus in sales (one-third of Biogen’s revenue). Lately, though, sales growth has slowed, partly because a few patients developed the potentially fatal brain infection PML. While Tecfidera still outsells two competing drugs – Gilenya from Novartis (NYSE: NVS) (Income/Value Portfolio) and Aubagio from Sanofi – those rival drugs are growing faster. Moreover, a Celgene MS pill in phase 3 studies appears to be a safer version of Gilenya and might eat into Tecfidera sales. We will monitor developments closely.

On the positive side, in 2017 Biogen reached deals with two potential generic challengers to Tecfidera. Tecfidera should remain a multi-billion-dollar staple even if sales growth is less than originally expected.
Meanwhile, newly approved Spinraza (spinal muscular atrophy) has surged out of the gates faster than projected. In its third full quarter on the market, quarterly sales reached $270 million and annual sales should top $1 billion in 2018.

A potential future home run could be aducanumab, a possible treatment for Alzheimer’s. Biogen has teamed with Japanese company Eisai to co-develop the drug, whose fast-track status will shorten the regulatory process.

Aducanumab appears able to reduce buildup of amyloid plaque in the brain. Results from phase 3 studies are expected in late 2019 or early 2020. Biogen also has a stake in another Alzheimer’s drug, BAN2401, that Eisai now has in phase 2 tests. Results are due out in 2018.

In early 2017 Biogen spun off its hemophilia assets into newly formed Bioverativ (NASDAQ: BIVV). Its two drugs, Eloctate and Alprolix, produce combined annual revenues of about $1.1 billion, with low-to-mid-teen sales growth expected in 2018. The drugs throw off more than $300 million in annual free cash flow, funding a pipeline that will drive future growth.
 Bioverativ’s goal is to create a hematology franchise, and it has eight programs in early stages. Recently, a phase 1b clinical trial studying BIVV009 in patients with a rare blood order called cold agglutinin disease (CAgD) showed good efficacy and safety data. The drug (like Biogen’s aducanumab) is a “monoclonal antibody”, meaning it can bind to specific cells or proteins, allowing for targeted therapy. The FDA has designated BIVV009 as a breakthrough therapy and orphan drug, an indication it has great promise.

Lastly, a word on Thermo Fisher Scientific (NYSE: TMO), a strong and steady performer both in the market and in terms of its fundamentals and product offerings. It doesn’t develop drugs, but its products – a broad range of analytical instruments, equipment, reagents, consumables, and software – are crucial to companies that do. The health care industry accounts for around 55% of its revenue, with industrial research and academic/government services generating the rest. Its high free cash flow drives consolidation in a fragmented industry.

The company’s fastest growth, admittedly from a small base, is in emerging markets. Its growth in China has exceeded 20% over the past five years.

We expect overall growth in revenues, earnings, and free cash flow in the low teens over the next five years. Despite Thermo Fisher’s strong market performance, its PEG of 1.3 is below that of the slower-growing S&P, pointing to sharply undervalued shares.

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