By Lewis Krauskopf
NEW YORK (Reuters) - Away from the political spotlight on Obamacare and high medicine prices, a section of the U.S. healthcare industry is quietly thriving on the stock market.
The S&P 500 life sciences tools and services index, which includes companies such as Waters Corp (NYSE:WAT) and Thermo Fisher Scientific Inc (NYSE:TMO) that provide laboratory instruments for research by pharmaceutical companies, academia and industrial labs, has soared 27 percent this year. That tops the 9 percent rise for the broader S&P 500 healthcare sector, which has been hampered by uncertainties of President Donald Trump's healthcare policies, including his vow to repeal and replace the 2010 Affordable Care Act, known as Obamacare. House Republicans approved the repeal in early May but it faces an uncertain future in the Senate.
A strong first-quarter reporting season has lifted life science shares but a big boost came after Congress earlier this month passed a bill to keep the government open through September that adds $2 billion in funding to the National Institutes of Health (NIH), which funds medical research.
"They’re not really part of the healthcare reform debate. They’re not part of the drug-pricing debate, so they really have minimal headline risk," said Teresa McRoberts, portfolio manager at Fred Alger Management in New York.
“People are looking for alternatives to pharma and alternatives to biotech, and so I think these stocks are getting bid up as alternatives to those. Plus, their fundamentals have been fine."
Whether the shares, which are generally trading well above historic valuation levels, continue to outperform could rest not only on the companies' ability to grow at healthy rates, but also on if other healthcare industries become more appealing and lure away investors.
"Sector rotation is a continuing risk for the life science tool sector," said Paul Knight, an analyst with Janney Montgomery Scott.
These companies appeared to have dodged a political bullet of their own. President Donald Trump's U.S. budget released on March 16 proposed a cut to spending for the NIH, which represents about 24 percent of all academic-related spending in the life-science tools sector, according to Cantor Fitzgerald analyst Bryan Brokmeier.
The life sciences index dropped 2.1 percent that day, its biggest single-session decline in about five months. But on May 1, as news emerged of the NIH funding boost, the index gained 0.9 percent.
In PerkinElmer Inc's first-quarter conference call on May 4, Chief Financial Officer Frank Wilson said the company was hopeful that, along with industrial trends, "this week's announcement to fund the NIH will help improve organic revenue growth in the second half of 2017."
"The boost to the NIH budget is definitely a tailwind," said Jeff Jonas, a portfolio manager with Gabelli Funds in Rye, New York. "The assumption is that both parties generally support this funding, and I think the assumption is that they will resist any cuts."
Life sciences markets represent about 65 percent of the business for the industry, according to Janney's Knight, although that amount varies among companies, which also sell products that gauge air quality in countries such as China or measure food safety.
As a result of their stock runs, the six S&P 500 companies, in the group which also include Mettler-Toledo International Inc, Agilent Technologies Inc (NYSE:A) and Illumina Inc (NASDAQ:ILMN), are trading on average at 27.4 times earnings estimates for the next 12 months, well above their five-year average of 22.8 times.
By contrast, the S&P healthcare sector is trading at 15.7 times estimates, only slightly above its five-year average of 15.4 times.
Companies on average reported revenue growth of 5 percent in the first quarter, ahead of last year's revenue growth rate of 3 percent to 4 percent, Knight said.
"I think you have to maintain or exceed that growth rate in the rest of the year" for the stocks to continue their strong performance, Knight said.