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Four Stocks to Play the Future of Healthcare Innovation

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Debra Netschert’s path to healthcare investing started with hips and knees.

In the late 1990s, she was finishing up a master’s degree in physical therapy, working rotations in orthopedic rehabilitation, and treating patients who had recently had joint-replacement surgery. “I got to learn about the companies that were developing the hardware used in the surgeries, and I just loved it. I realized I was attracted to the innovation part of healthcare,” says Netschert, a portfolio manager at Jennison Associates, which manages more than $2 billion in its health-sciences strategies.

Along with partner Dan Matviyenko, Netschert manages the $1.6 billion
PGIM Jennison Health Sciences
fund (ticker: PHLAX). The fund is down 14.53% this year, but has delivered solid returns over three years, besting 77% of its peers, according to Morningstar. Over 15 years, the fund has outperformed 87% of its peers.

Barron’s caught up with Netschert recently in New York to talk about the outlook for biotech, the stocks she is most excited about, and what the recent Inflation Reduction Act means for pharmaceutical companies. An edited version of our conversation follows.

Barron’s: You’ve been a healthcare investor for 22 years. What are you most excited about in the coming decade?

Debra Netschert: We’re seeing a lot of innovation across the healthcare spectrum, from advances in technology to changes in consumer demand. Covid helped us see the cracks in the healthcare system. If you look at the millennials, they aren’t going to resign themselves to the bureaucracy and inflexibility and the one-size-fits-all approach to healthcare; they’re going to demand more control and more information. They’re going to want to use data and technology, and they’re going to ask the right questions. They’re going to keep pushing for the healthcare system to get better.

We’re focused on finding companies that we think are going to improve the human condition and address a very large unmet need. One big focus of ours has been obesity. We’ve been tracking the obesity space for many years, and we’re really excited about the treatments that
Eli Lilly
[LLY] has for diabetes.

Eli Lilly is one of your top three holdings. What is so great about it?

Lilly is one of the best-run pharma companies. Its innovation has been top-notch, and its clinical success rates are some of the highest in the industry. It has done an incredible job of coming up with best-in-class molecules, which speaks to the research and development happening at the organization. Lilly is launching a drug called tirzepatide—the brand name is Mounjaro—and it is one of the best diabetes drugs we’ve ever seen in terms of its ability to manage blood sugar, but it also has the benefit of promoting weight loss. The Food and Drug Administration approved Mounjaro for diabetes earlier this year, and the company plans to complete its request for approval of the drug as an obesity treatment next year.

Diabetes and obesity both fall under the metabolic-syndrome umbrella. A lot of systems can go awry to create metabolic syndrome. Over time, we believe that weight loss is going to improve with this drug, and we are going to start to see an improvement in metabolic syndrome, which will ultimately lead to an improvement in cardiovascular health and a decrease in strokes and heart attacks. The cost of care is going to come down, and you’re going to improve the overall health of a patient. If you think about it from the perspective of the payer—the managed care company that pays benefits through its health-insurance plans—cardiovascular disease is still one of the highest-cost categories.

Obesity has been viewed more as a lifestyle issue than a disease, and we haven’t seen reimbursement for obesity medication. But if this drug, and this class of drugs, are shown to decrease cardiovascular events, the payers will wake up to understanding the positive impact these drugs can have on the overall cost of care. They’ll be more motivated to approve a drug for obesity.

Biotech is one of the biggest allocation in your portfolio, at roughly 24.5%. Which stocks do you like?

Apellis Pharmaceuticals
[APLS] is developing a therapy for a disease called geographic atrophy—a progressive eye disease that leads to blindness and has no available therapies. The disease is caused by lesions on the outer retina, and the goal is to stop these lesions from growing, to preserve vision over time. Apellis has done many clinical trials and has filed for FDA approval for a treatment called intravitreal pegcetacoplan. I’m superexcited for an impressive launch for a disease with a high unmet need and no available treatments at this time.

What is another one?

Argenx
[ARGX] develops antibody-based medicines for autoimmune disease and cancer. Its flagship drug is Vyvgart. This is a first-in-class molecule that targets and blocks the Fc receptor [FcRn], lowering the antibodies that cause generalized myasthenia gravis, a rare autoimmune disease. Last year, the FDA approved Vyvgart for myasthenia gravis, and the launch has been spectacular. Revenue generated by Vyvgart has beaten consensus estimates every quarter since the launch. It’s a highly effective drug with convenient dosing. We think it will be used for many other diseases over time.

Biotech stocks have been on a roller coaster. They took a dive in the first half of the year but recovered in the second half. What is your outlook?

In the past few years, too many biotech companies came to the public markets with immature and unproven science. In 2023, we are going to continue to unwind the massive amount of company creation. This will mean the companies that have technologies and/or drugs that are safe and effective and demonstrate a major advance over what is available to patients today will be rewarded, while those that came to the public markets with subpar science or poor drug-development plans will fall to the wayside and potentially go bankrupt. This is a great time for active managers who have expertise in the biotech space and can distinguish the haves from the have-nots.

Let’s switch gears to healthcare providers. Your top holding is
UnitedHealth Group
[UNH]. Why?

We’ve owned the stock since 2011. You asked earlier what I’m excited about, and one other area is the utilization of healthcare and how that’s changing, both in terms of the way we’re using healthcare and where care is happening. A trend that we’re enthusiastic about is the movement toward value-based care, which is aligned with our investment goal of finding innovation that is going to improve the human condition by both improving the quality of care and lowering the overall cost of care.

What is value-based care?

In the past, healthcare providers were rewarded for the volume of goods and services they provided rather than the quality of care they provided to patients. This led to increased costs and less-than-optimal outcomes for patients. In a value-based care environment, providers are rewarded for the quality and effectiveness of the care they provide. This means that the healthcare system is focused on providing better clinical experiences and outcomes for patients at a lower overall cost of care.

United is a leader in its managed care business and in value-based care, but many people think about it as only a managed-care company and an insurance provider. To see the impact it is having on value-based care, you also need to look at the Optum side of the business, which includes Optum Health, Optum Insight, and Optum Rx. Optum Health is focused on value-based care. They do everything from in-clinic care to home care to delivering end-to-end financing and payment solutions to make the payment side of healthcare easier for the patient and the provider.

They’re also doing a lot of work at the physician practice level. For example, United buys a physician practice and incentivizes the physician to provide the same or a better level of care—measured by health outcomes or satisfaction—to the patients in the practice for less money. Those cost savings are split by United and the physicians. In addition to improving the profitability of the practice, the physicians also benefit from having access to United’s massive infrastructure.

What sort of upside do you see for United’s shares?

We are only in the third inning of value-based care, so this provides a lot of upside for United in the years to come. The company just announced its preliminary 2023 earnings-per-share guidance of $24.40 to $24.90 a share, which represents 11% to 13% growth from the 2022 midpoint. We believe there is still upside in the stock, as we expect the company to grow earnings per share in the 13% to 16% range for the next couple of years, and the stock to maintain a multiple in the low 20s.

The Inflation Reduction Act includes some healthcare-related measures aimed at lowering drug costs. What does it mean for pharma companies?

It is a positive to finally have a bill passed giving the industry clarity. But there are some parts of the bill that could stifle innovation and leave some companies flat-footed.

One of the most consequential parts are provisions that give the federal government the ability to negotiate prices, at a defined number of years after a drug is launched, for the drugs that are the costliest to Medicare. Importantly, this time period is different based on the type of molecule. The price of small molecules, or pills taken by mouth, can be negotiated nine years postlaunch, while biologics, or large molecules typically injected or infused, will be negotiated 13 years postlaunch.

If this provision remains intact, the motivation for the biopharma industry to develop a pill will likely be lower. So, what happens to the companies currently developing small molecules? It is fair to say that a big wrench has been thrown into their business plans. This part of the bill is also going to make research-and-development organizations rethink the way they develop drugs and the number of diseases they develop a given drug for.

While this will stifle innovation to a degree, it will favor the development of the most innovative and effective drugs, many of which are developed by the smaller-cap biotech companies. And because the larger biopharma companies are going to need to launch more-effective drugs more often, and can’t possibly develop enough of these drugs on their own, we believe this will lead to more mergers and acquisitions. That will also be a long-term positive for the biotech industry.

Thanks, Debra.

Write to Lauren Foster at lauren.foster@barrons.com

Credit: marketwatch.com

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