Health-Stock Refuge No Refuge at All

by Vanessa Fuhrmans

In past economic downturns, investors looking for cover from falling share prices could always run to health-care stocks. This year, though, that classic safe haven appears worse than the storm.

Recession or not, people get sick and use prescription drugs, medical devices and plenty of other medical services. That’s the driving logic behind the health-care industry’s usual resistance to the economy’s twists and turns.

But so far in 2008, health-care stocks have taken an even bigger beating than most. The Dow Jones Wilshire U.S. Healthcare Index is down 11% since year end. By contrast, the Dow Jones Industrial Average is down 5.9%, after losing 3.9% last week, and the Nasdaq Composite Index is down 7.8%, after tumbling 3.3% last week.

Some of the biggest managed-care and pharmaceutical companies have led the plunge. Humana, one of last year’s top performing health insurers, is down 35% this year, while WellPoint and Health Net have dropped 39% and 36%, respectively. Among drug makers, Merck has fallen 33%, while generics maker Barr Pharmaceuticals is down 19%.

What happened? Many companies have been simply overwhelmed by their own problems, such as lackluster drug pipelines, regulatory snafus or miscalculations in pricing health-care plans.

But long-time health care investors say a more fundamental change is also taking place: As the cost of health care continues to soar, consumers are having to shoulder an increasing amount of the cost on their own — and some are cutting back where they can.

“That’s a big change over the past five years, and certainly in the last 10 years,” says Kris Jenner, who manages T. Rowe Price Health Sciences Fund. As insurers and employers shift a greater share of the cost of health care onto individuals, “it’s making health care much less resistant to economic forces.”

On top of that, the presidential election season adds another layer of uncertainty, though “the actual fundamentals are more in question than any potential policy change,” Mr. Jenner adds.

The shift is putting pressure on different health-care sectors in different ways. Hospital chains see rising levels of bad debt, as some patients can’t or don’t pay their portion of bills. Insurers have been struggling to meet their targets for the growth in health-plan enrollment for a couple years now, because the overall market of jobs with health benefits has stagnated.

WellPoint, which has lowered its 2008 profit forecast already twice this year, has said more small businesses facing hard times are dropping or cutting back coverage. It has also seen membership numbers go down within existing employer accounts — suggesting more workers or their dependents can’t afford the premiums the employers require them to pay.

Employers squeezed by health-care costs are turning to options such as self-insuring or providing high-deductible plans, but those aren’t as profitable as traditional coverage for health-plan providers.

“It puts a real squeeze on their business model,” says William Rutherford of Rutherford Investment Management in Portland, Ore., who says he has shied away from the managed-care sector.

Companies with fast-growing consumer-health franchises not affected by health insurance, such as aesthetic lasers and eyesight-improvement surgery, are more directly vulnerable to the economy. Allergan, the maker of Botox, for instance, is down 16% since year end.

Likewise, the higher copays people are paying for brand-name drugs are exacerbating an already big problem for big pharmaceutical makers: fierce generic competition. In the past two recessions, drug makers were riding high on a wave of blockbuster drugs. Now, many face patent expirations and have come up dry in the search for new and innovative drugs.

Even companies with established drug portfolios face higher risks than before. After several drug scares and recalls, such as that of Merck’s painkiller Vioxx, drug regulators have been responding more aggressively to safety concerns. “It adds a whole new element of uncertainty,” says Rob Junkin, who manages Evergreen Health Care Fund.

Investors say they still see plenty of defensive plays in certain niches — and, after so many price plunges, a lot of value, too.

For instance, Mr. Junkin likes both Allergan (AGN) and Barr Pharmaceuticals (BRL) after their big share price declines. Besides Botox, Allergan has a solid and promising eye-care business, he says. Though Barr’s first-quarter sales and earnings were below expectations, it remains well-positioned to take advantage of growing generic drug use and recently won approval to market a version of Yasmin, a popular oral contraceptive.

Mr. Rutherford says he’s putting more money in companies aimed at containing costs, such as pharmacy benefit manager Express Scripts (ESRX). He says medical devices are also a safer bet, as they face fewer regulatory challenges than drugs. A common favorite among investors is Hologic (HOLX), which develops and supplies digital mammography and other advanced-imaging systems for women’s health needs.

Big biotech looks more promising than big pharma, says David Smith, chief investment officer for Rockland Trust’s Investment Management Group in Massachusetts. Genentech (DNA) has a broad portfolio of drugs with little patent-expiration risk and more in development, he says.

Biotech, in fact, is a bright spot in the health-care world, with a Dow Jones Wilshire biotech index up a slight 0.2% since year end.

Mr. Jenner also has been investing big in the area; stocks he likes include Alexion Pharmaceuticals (ALXN) and Bio-Marin Pharmaceutical (BMRN).

Copyright (c) 2008, Dow Jones & Company, Inc.