3 Undervalued Healthcare Stocks to Watch as Sector Struggles

Key Points

• The healthcare sector offers defensive characteristics with steady cash flows and dividends, making it attractive even during economic downturns.
• Despite recent declines, the healthcare sector has outperformed the broader S&P 500 in the past three months.
• Zimmer Biomet, Moderna, and Illumina are among undervalued stocks in the sector, with the potential to post big gains in the not-so-distant future.
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The Health Care Select Sector SPDR Fund NYSEARCA: XLV is down 2.40% in the past three months, and down 4.67% year-to-date. 

With the current sector-wide downturn, it’s not surprising that several large healthcare stocks are currently undervalued, relative to their intrinsic value, based on their fundamentals, cash flows, and future earnings potential. 

Those undervalued names include Zimmer Biomet Holdings Inc. NYSE: ZBH, Moderna Inc. NASDAQ: MRNA and Illumina Inc. (NASDAQ: ILMN

Meanwhile, heavily-weighted healthcare stocks such as UnitedHealth Group Inc. NYSE: UNH, Johnson & Johnson NYSE: JNJ and Merck & Co. Inc. NYSE: MRK all show volatile chart action recently, which is contributing to the broad sector decline.

Part of the sector-wide volatility is because investors are uncertain about the economy in the coming months, as well as projecting higher interest rates. 

Healthcare's Defensive Characteristics

However, in addition to having some growth elements, healthcare stocks have defensive characteristics as demand remains even during weakening economic conditions. 

In the past three months, the healthcare sector is still ahead of the broader S&P 500, which is down 4.31% during that time. 

The sector will generally have appeal to dividend investors, as healthcare stocks often pay dividends due to their stability and consistent cash flows. For example, the XLV ETF, comprised of 65 stocks, has an aggregate dividend yield of 1.7%.

Zimmer Biomet: Undervalued Orthopedics Giant 

Zimmer Biomet, with a market capitalization of $22.84 billion, designs,

manufactures and markets orthopedic reconstructive products in the categories of sports medicine, trauma products, surgical products and other categories. It also makes and markets a suite of integrated digital and robotic technologies. 

The company’s shares are trading at November 2022 levels, after declining from rally attempts in May and June. A look at the Zimmer Biomet chart will show you that shares closed at $109.30 on October 5. That’s 9.4% below its 50-day moving average and 15.2% below its 200-day line.

Wall Street expects Zimmer Biomet earnings to decline by 22% this year, to $5.37 a share, but analysts see growth rebounding to 10% next year, to $5.90 a share. 

Zimmer Biomet analyst ratings also indicate some of that optimism: Analysts have a “hold” rating on the stock with a price target of $144.89, an upside of 32.59%. 

Moderna Off Its Pandemic-Era Highs

If you look at the Moderna chart, you’ll quickly notice that the stock has been in gradual decline since its August 2021 high of $497.49. The company’s Covid vaccine sales resulted in an earnings bonanza in 2021. Earnings fell in 2022, but the company is expected to report losses this year and next. 

Moderna has a problem: To put it mildly, interest in the vax has waned significantly. The company needs to build out a new product pipeline.

Fortunately, Moderna is looking to flu shots and other respiratory viruses as potential cash cows. It aims to have a wide portfolio of vaccine treatments for respiratory viruses.

In September, the company announced positive Phase 3 clinical trial results for its mRNA flu vaccine. Over the next five years, the company expects to launch up to 15 new products addressing several unmet needs. It plans to have as many as 50 new candidates in clinical trials,  and expand the field of mRNA into new applications. 

Moderna is a bit of a wild card at the moment, but as various products in the pipeline get regulatory approval and come to market, the stock is likely to bounce back. 

Illumina: Was the Company Its Own Worst Enemy?

Illumina specializes in the growing area of genomic sequencing. The company develops a wide spectrum of products aimed at researchers and clinicians who need to identify and study genetic variations. 

Genomic sequencing is an industry undergoing rapid growth as an increasing number of applications are put into practice. 

MarketBeat’s Illumina chart shows a stock whose price has been on the decline since mid-2021. 

This is a company involved in cutting-edge technologies, but one that’s also had some self-inflicted wounds, which are largely responsible for the price decline.

The Securities and Exchange Commission is investigating Illumina's $7 billion acquisition of Grail, a genetic-testing company. Illumina went through with the acquisition despite regulators’ objections. It’s under scrutiny now in the U.S. and Europe. 

In addition, its new gene sequencing technology, NovaSeq X, is not driving revenue growth as the company had hoped.

You can look at Illumina’s earnings data to see earnings have been declining, while revenue growth has been tepid or non-existent. 

However, some analysts believe a new management team can turn things around. For example, the company has the finances to cover European fees related to the botched Grail acquisition, which it may yet have to divest. In addition, the new CEO has plans to expand into India.

Illumina may be a case of a stock that’s so far down, that pretty soon there will be nowhere to go but up. 

Wall Street expects earnings to decline by 62% this year to 81 cents a share, but growth is expected to bounce back strong next year, to the tune of 174%, to $2.23 per share.