Month 148 - 12 Healthcare companies that issue A-rated bonds - November 2023

Situation: Healthcare stocks have fallen almost 10% since July, mainly because of two events: 1) the adoption of appetite-suppressants to treat obesity, 2) the adoption of price controls for Medicare drugs. Obesity is a risk factor in a dozen important illnesses, and a widespread reduction in obesity would impact cash flows of the healthcare industry. The good news is that healthcare costs for the average citizen would fall, closing the gap between supply and demand.

Mission: Analyze healthcare companies that have no material risk of bankruptcy (issue bonds rated A- or better by S&P).

Execution: See Table of 12 companies.

Analysis: Warren Buffett’s favorite metric is Return on Tangible Capital Employed (Column T in the Table). He thinks a 20% return for the last fiscal year (lfy) is a good number. 10 companies qualify: LLY, CI, MRK, UNH, BMY, JNJ, TMO, DHR, PFE, ABT. His second point (that the company be “run by able and honest managers”) is addressed in Morningstar Reports (Column AR) and negatively impacted by the degree to which the company is capitalized by issuing long-term bonds (Column AA). 5 companies have a BUY rating from Morningstar (CI, ELV, BMY, PFE, MDT), and 10 have a Debt to Equity ratio lower than 1.0 (CI, MRK, ELV, UNH, JNJ, TMO, DHR, PFE, ABT, MDT). Mr. Buffett also likes Free Cash Flow Yield (Column K) to be higher than Dividend Yield (Column J) because Retained Earnings allow the company to expand operations (or pay down debt) at zero cost; 11 companies qualify (CI, MRK, ELV, UNH, BMY, JNJ, TMO, DHR, PFE, ABT, MDT). His third point (that the stock be available “at a sensible price”) is addressed by 1-yr and 3-year Forward PEG ratios (Columns O and P); 8 companies have PEGs under 2.5 at both intervals (LLY, CI, MRK, ELV, UNH, BMY, TMO, MDT). One company (JNJ) is A-rated. 6 companies (see Appendix) are Hardy Perennials: LLY, ELV, UNH, JNJ, TMO, DHR; 4 companies are cited 5 times (ELV, UNH, JNJ, TMO).

Bottom Line: Big Pharma is on sale.

Risk Rating: 7 (where 10-yr Treasury Notes = 1, S&P 500 = 5, gold = 10).

Full Disclosure: I dollar-average into LLY, MRK, JNJ, DHR and PFE, and also own shares of UNH and TM

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Appendix: We call a company that is sustainably able to make money a Hardy Perennial. There are 5 requirements:

–it has a better Finance Value (Column G) than the S&P 500;

–it issues bonds rated A- or higher by S&P;

–it has an ROIC that exceeds its WACC (Columns W&X);

–10-yr total return/yr exceeds 10-yr Required Rate of Return (Columns D&E);

–5-yr Beta (Column C) is less than the S&P 500’s 5-yr Beta (fixed at 1.00).