Eoneren/E+ via Getty Images

Eoneren/E+ via Getty Images

Over the past few months, there has been a shift in market sentiment. Investors have moved away from aggressively delivering alpha through risky assets to finding investments that will help them lay low for the next few quarters as they digest inflation, the federal reserve's decision to raise rates, and the Russia-Ukraine war. During this period we believe that the S&P's 4th best-performing sector YTD, healthcare, can offer some help.

Healthcare and inflation have historically been positively correlated. The last time we had an inflationary period that compares to the present day was from 1998 to 2000. From trough to peak, the S&P healthcare sector had a correlation coefficient of +0.4 with inflation:

A correlation coefficient measure how closely related two data sets are on a scale from -1 (inverse relationship) to +1 (direct relationship). We find an even stronger connection from 2020 to 2022, which has a trough to peak correlation coefficient of 0.94:

Both instances reflect how healthcare stocks tend to have strong returns when inflation skyrockets. While other sectors must worry about consumer purchasing power, eroding margins, etc., capital tends to flow into healthcare which steers clear of these issues.

Inflation can also spark recession fears with the federal reserve raising rates to cool off the economy. Both 2000 and 2022 saw this, and investors flew from growth equities to pockets of the market like healthcare, which is more value-oriented.

From March 2000 (highest inflation read during the crisis, the beginning of the recession, and near the last rate hike of 50 basis points) to October 2002 (end of the bear market), healthcare was the second-best performing sector, handily outperforming the S&P by 35.7%:

And a similar story has unfolded since November 2021, with healthcare outperforming by 10%:

Front-end (rapid rise of inflation) to back-end (rising rates and economic downturn) healthcare is almost always a winner. Companies creating medical treatments and providing healthcare plans and services base their business on universal health needs, something that will always keep growing.

In our current environment, we find that managed care, pharmaceutical, and biotech companies are the most investable as they have the highest YTD rates within the sector:

Yardeni Research, Standard & Poor's

Yardeni Research, Standard & Poor's

Now let's dive deeper into our top picks for each of these subsectors.

UnitedHealth Group is the largest managed care company, serving over 146 million people. The company is divided into UnitedHealthcare, which provides Medicare and Medicaid services, and Optum, which has major subdivisions like Optum Health; Optum Insight; and Optum Rx. Both delivered superb growth over the past quarter with their healthcare division revenue up 13.6% year-over-year:

and Optum revenues up almost 19% year-over-year:

This diversification will come in especially handy as managed care companies run into their first big test: the public health emergency (PHE) designation. During COVID-19, the government required beneficiaries to be enrolled every year, but when PHE status is lifted enrollment churn will skyrocket as members are released from their plans.

UnitedHealth is in an attractive position to deal with these issues. Only 17% of total enrollment is Medicaid, which is second-to-last when compared to competitors like Molina (MOH) with 83% exposure or Centene (CNC) with 56% exposure. And although they are the leading Medicare company with a 15% market share, the difference between it and the last major competitor is just 8% due to market saturation.

Additionally, growth through its Optum brand should offset any potential losses. The expansion of Optum Health's offerings resulted in a 33% growth in revenue-per-consumer this past quarter, doing so well that the company upwardly revised the number of patients they will serve by 20%. Optum Rx posted its high growth since Q1 2020 at 11% with doctor visits normalizing. And Optum Insight has consistently increased its backlog by double-digits for the past 4 quarters as the company moves deeper into digitally modernizing healthcare.

Even more exciting is their $13B acquisition of Change Healthcare (CHNG) which should significantly enhance their patient engagement systems and give them a leg up in data analytics and simplifying healthcare payments, boosting operating margins. What sweetens the deal is that only $5B was added to the balance sheet, $3.7B of which was paid off during the last quarter, barely making a dent in its debt-to-equity ratio:

Author, Stock Analysis, Yahoo Finance

Author, Stock Analysis, Yahoo Finance

Even amid a slight debt increase, its reported 0.62x financial leverage was the lowest in company history. This exceptional financial standing, paired with its positioning to take advantage of tailwinds in key markets, creates a fantastic opportunity that investors should pounce on.

Amphastar is a biopharmaceutical company that produces generic inhalation and intranasal treatments. Unlike other slumping generic drug makers, the company has leveraged its robust business model to report consistent growth and lay the foundation for long-term success.

Every drug has an active pharmaceutical ingredient (API) working inside of it (e.g. Ibuprofen for Advil). Amphastar focuses its R&D on creating drugs with APIs that are extremely difficult to source/manufacture. Because the company has specialized manufacturing capabilities via subsidiaries, they can produce this hard-to-access drug in-house and sell it by themselves. Essentially they have a large operational moat in drugs that already have high barriers to entry, insulating them from any competition.

Moreover, because the company takes care of everything from research and testing to production and marketing, they have an extremely streamlined process with high-efficiency rates. This year, Amphastar reported record operating margins of 15.96%, far above industry giants Teva (TEVA) with 10.18% and Viatris (VTRS) with -0.19%. And "record" was a common theme across the income statement. While Teva reported negative revenue growth and Viatris reported a near doubling of losses, Amphastar's net income skyrocketed to $62M with EPS of $1.30, both drastically higher than the $1.4M and $0.03 figures in 2020.

On the back of two major launches, Primatene MIST (first FDA-approved over-the-counter asthma inhaler) and Glucagon (emergency kit for extremely low blood sugar):

Amphastar at Needham's Healthcare Conference

Amphastar at Needham's Healthcare Conference

2021 marked the first year that Amphastar was able to put everything together, reaping the benefits from its sound growth strategy. The company also has 2 more products ready to launch in 2022:

Amphastar at Needham's Healthcare Conference

Amphastar at Needham's Healthcare Conference

Despite these major launches, they don't depend on them as "blockbuster drugs" as they have a well-diversified portfolio of over 20 products:

Amphastar at Needham's Healthcare Conference

Amphastar at Needham's Healthcare Conference

Its strong revenue base combined with multiple potential product releases prime Amphastar for solid long-term growth. The company's differentiated business model is working and makes it an attractive bet in a subsector seeing many companies go backward.

Regeneron is a large, diversified biotechnology company working on several advanced treatments and therapy. Its numerous partnerships have led to two blockbuster drugs: EYLEA, with Bayer (OTCPK:BAYRY), and Dupixent, with Sanofi (SNY), each of which continues to post impressive growth. Despite a decade in the market, EYLEA grew its sales by 18.4% year-over-year and Dupixent continued its straight-line trajectory with sales up 53%.

The company also has a diverse pipeline of 30+ drugs including phase 3 collaborations with Teva and Alnylam and phase 1-2 collaborations with Intellia (NTLA) and Ultragenyx (RARE):

But in a landscape of young, ambitious biotechs which have grown in popularity and established players entrenched in their own markets, what separates Regeneron from the pack? Its rare combination of treatments and financial security.

Because the FDA trial and approval process can take years, firms get locked up in decade-long partnerships, accumulating debt on the balance sheet for products that haven't even sold a dime. What's worse is everything could go to waste if the FDA says "no," and companies would be left responsible for the debt, almost like getting expelled from college but still having to pay the student loans.

This is where companies need to have good cash flow coverage, meaning operating cash flows running through the company should be able to cover total debt (ideal ratio of 1). Regeneron is only third to Novo Nordisk (NVO) and Vertex (VRTX) which reflects a mature biotech company relative to an industry with few cash lush companies:

Moderna (MRNA) was excluded due to upside skew

Compounding on the issues, biotechs must continually invest in R&D to keep up with competitors, for example, chasing Moderna and BioNTech (BNTX) in the mRNA race while dealing with manufacturing, advertising, and other general costs that build operating expenses.

In 2021, Regeneron had its highest R&D spend and operating expense to date, even spending a record $287.6M just to advertise Dupixent. Yet operating margins still grew to the highest amongst competitors, meaning profits outpaced by a wide margin:

Moderna, BioNTech, and Alnylam (ALNY) were excluded due to downside skew

When it comes to having an exceptional pipeline and the financial excellence to back it up, Regeneron certainly fits the billing, being one of the few "safe" ways to play the biotech space.

With Powell announcing a 50 basis point rate hike, the largest since the 2000-01 crisis, stocks are in flux between inflation and the fed. In these volatile periods, markets have historically favored healthcare as a safe haven - and history is simply repeating itself. To temper the uncertainty, we believe cash-rich names with long-term growth stories like UnitedHealth Group, Amphastar, and Regeneron have the potential to provide diversity and stability to any portfolio.

This article was written by

Disclosure: I/we have a beneficial long position in the shares of REGN either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.