Defensive Nature Sweetens Pill for Pricey Sector

(Bloomberg) -- With the market poised to end August with some major losses, defensive sectors have naturally shown good resilience. That has helped health-care shares extend a strong outperformance over the market that has lasted for more than a year now. Although the sector is approaching an all-time high relative to the Stoxx Europe 600, its benefits may yet continue to offset the challenges ahead.

Health-care companies had a pretty good second quarter, with 8.3% EPS growth, compared with 0.4% for the European market overall, according to JPMorgan. It also has received consensus upgrades for the second half. One factor that has particularly boosted pharma earnings in Europe is the strong dollar, which is still hovering near two-year highs.

Looking at valuations, the sector has a high relative P/E, at 17.7 times its 12-month earnings compared with a multiple of about 13.5 for the broader market. Still, the premium is not without basis, given the sector’s faster earnings growth. As for the dividend yield, it’s still better than most of the highest-valued sectors.

The U.K.-listed components of the sector, mainly AstraZeneca and GlaxoSmithKline, which account for about 17% of the SXDP, are particularly interesting at a time when the pound is on its knees versus the dollar. In case of a no-deal Brexit, both stocks would rally, Morgan Stanley analysts estimated earlier this month, adding that pharmaceuticals have been the most correlated equities to the pound weakness over the last five years.

U.K. pharma may also benefit from another phenomenon, a switch from a sector that used to have similar defensive features: tobacco. “The whole pivot has changed,” explains Ketan Patel, a fund manager at Edentree Investment Management Ltd. who owns many of the big pharma stocks. Patel says health-care stocks, and large caps in particular, are now outperforming the sector in terms of cash flows and dividends, but without the negative connotations that tobacco stocks bear in terms of health.

Looking at the performances of the FTSE 350 Pharmaceuticals and the FTSE 350 Tobacco, the gap between the two sectors has widened dramatically since last year, in sharp contrast with the close link that seemed to tie them previously. One thing that could help tobacco recoup some losses might be consolidation, especially after Philip Morris and Altria confirmed merger talks.

Health-care stocks still have some challenges ahead, particularly the U.S. pricing reform that remains an overhang, or a drastic change in the dollar outlook. That has not stopped the sector so far. “We’re very, very positive on pharma and health care in general,” Patel says. His firm owns shares of GlaxoSmithKline, AstraZeneca, Smith & Nephew, Sanofi, Novartis, Roche, AbbVie, Pfizer, Merck.

In the meantime, Euro Stoxx 50 futures are up 0.1% ahead of the open, while S&P 500 contracts are up 0.3%.

SECTORS IN FOCUS TODAY:

• Watch Italian bonds and stocks as President Sergio Mattarella will give Five Star and the Democratic Party a final chance to carve out an agreement, otherwise a set of potentially market-unfriendly elections will have to happen, casting uncertainty over the outlook for the country.
• Watch the pound and U.K. stocks after a U.K. official said the government is optimistic about restarting Brexit negotiations with the European Union.
• Watch construction software stocks, particularly Aveva and Nemetschek, after U.S. peer Autodesk cut its FY forecast, sending its shares tumbling in extended trading.
• Watch oil stocks after an industry report showed a bigger-than-expected drop in American crude inventories, pushing crude prices higher.

COMMENT:

• “While the recent escalation might have been priced in part and explains a lower sensitivity, we think the risk of further disappointment on the U.S.-China trade dispute remains high,” Goldman Sachs strategists write in a note. “With our Risk Appetite Indicator not yet at extremely negative levels which would point to a more positive asymmetry, we remain neutral risk across assets over 3 months in our allocation.”

NOTES FROM THE SELL SIDE:

• RBC upgraded H&M to outperform from sector perform, saying the retailer’s improvements open it up for share gain in major markets. Broker said valuation is undemanding given performance will likely improve and raised PT to SEK210.
• ASM International and BE Semiconductor cut to neutral from buy at NIBC, with the sector not seen as cheap and geopolitical issues expected to affect the market in coming months.

COMPANY NEWS AND M&A:

• BP Exits Alaska After 60 Years in $5.6 Billion Hilcorp Sale
• Thomas Cook to Get GBP450M investment from Fosun
• BBVA Plans to Offer Contingent Convertible Securities
• BAT Faces Heightened Juul Threat From Philip Morris-Altria Combo
• Royal Unibrew Sees FY Net Revenue, Ebit At Upper End of Range
• Roche’s Hemlibra Gets Swiss Approval for Haemophilia Therapy
• Aroundtown Raises FY FFO I Views On Back of Acquisitions (1)
• Naturgy to Outsource Network Services to Everis: Expansion
• Agfa-Gevaert Second Quarter Adjusted Ebit Beats Estimates
• ATP Raised Danske Bank Stake to 2.07% vs 1.8% Over 1H of 2019
• Baloise First Half Profit Beats Estimates
• Austrian Hotel Developer UBM Raises FY19 Pretax Guidance 18%

TECHNICAL OUTLOOK for Stoxx 600 index:

• Resistance at 382 (50-DMA); 395.1 (July high)
• Support at 371.1 (200-DMA); 365.5 (50% Fibo)
• RSI: 47

TECHNICAL OUTLOOK for Euro Stoxx 50 index:

• Resistance at 3,403 (61.8% Fibo); 3,439 (50-DMA)
• Support at 3,239 (June/August low); 3,305 (200-DMA)
• RSI: 48.4

MAIN RESEARCH AND RATING CHANGES:
UPGRADES:

• Chesnara upgraded to hold at Peel Hunt
• H&M upgraded to outperform at RBC
• Per Aarsleff upgraded to buy at SEB Equities; PT 260 Kroner
• Royal Unibrew upgraded to hold at Jefferies; PT 550 Kroner

DOWNGRADES:

• ASMI downgraded to neutral at NIBC; PT 72 Euros
• BE Semiconductor cut to neutral at NIBC; Price Target 27 Euros

INITIATIONS:

• Dassault Aviation rated new equal-weight at Morgan Stanley
• Leonardo rated new overweight at Morgan Stanley; PT 13.30 Euros
• Thales reinstated equal-weight at Morgan Stanley; PT 100 Euros

MARKETS:

• MSCI Asia Pacific up 0.6%, Nikkei 225 up 0.2%
• S&P 500 down 0.3%, Dow down 0.5%, Nasdaq down 0.3%
• Euro down 0.02% at $1.1088
• Dollar Index up 0.05% at 98.05
• Yen down 0.09% at 105.85
• Brent up 0.9% at $60.1/bbl, WTI up 1.2% to $55.6/bbl
• LME 3m Copper down 0.1% at $5678.5/MT
• Gold spot down 0.2% at $1539.7/oz
• US 10Yr yield up 2bps at 1.49%

ECONOMIC DATA (All times CET):

• 10am: (IT) Aug. Consumer Confidence Index, est. 112.7, prior 113.4
• 10am: (IT) Aug. Manufacturing Confidence, est. 99.6, prior 100.1
• 10am: (IT) Aug. Economic Sentiment, prior 101.2
• 10am: (EC) July M3 Money Supply YoY, est. 4.7%, prior 4.5%

To contact the reporters on this story: Michael Msika in London at mmsika4@bloomberg.net;Lisa Pham in London at lpham14@bloomberg.net

To contact the editors responsible for this story: Blaise Robinson at brobinson58@bloomberg.net, Namitha Jagadeesh

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