Life Sciences Stocks: A Healthy Outlook

S&P likes the fundamentals of one of the stronger-performing subindustries this year, and has buy ratings on seven names

The Standard & Poor's 1500 Life Sciences Tools & Services subindustry index is the newest member of the S&P Industry Momentum list (see below), indicating that its trailing 12-month price performance is now in the top 10% of all subindustry indexes in the S&P 1500. Year-to-date through Nov. 16, the S&P Life Sciences Tools & Services index is up 29.7% vs. a 3.0% gain for the S&P 1500. In the past 13 weeks, this subindustry index gained 12.3% to the market's climb of 0.8%.

Take a look at the accompanying chart of this subindustry index's weekly relative price performance since Dec. 31, 2006 vs. that for the S&P 1500. Since the subindustry index was added to the S&P 1500 in April, 2006, it does not have a long enough history to draw a traditional trailing 12-month relative strength chart. As seen by the chart, this subindustry has outperformed the S&P 1500 on a year-to-date basis.

Positive Trends Into 2008

There are 19 large-, mid- and small-cap companies in the subindustry index, 11 of which are covered by S&P equity analysts. Seven companies have favorable STARS rankings—4 STARS (buy) or 5 STARS (strong buy)—from S&P analysts: Applera-Applied Biosystems (ABI; 4 STARS; $34); Covance (CVD; 5 STARS; $82); Invitrogen (IVGN; 4 STARS; $90); PerkinElmer (PKI; 4 STARS; $27); Pharmaceutical Product Development (PPDI; 4 STARS; $40); Thermo Fisher Scientific (TMO; 5 STARS; $58); and Waters (WAT; 4 STARS; $77).

Jeffrey Loo, CFA, who follows the Life Sciences Tools & Services subindustry for S&P, has a positive fundamental outlook for the group. His view is based on S&P's continued favorable view of the contract research organization group and improving growth for life science equipment and consumables. Loo thinks equipment manufacturers are benefiting from end users upgrading equipment and buying new products, and he sees these trends continuing into 2008.

The life sciences industry is dependent on pharmaceutical and biotechnology research and development spending and worldwide government funding. S&P sees high single-digit increases in R&D spending balanced against soft worldwide government funding that may temper overall sales growth. In the U.S., Loo continues to anticipate limited increases in the National Institutes of Health budget over the next several years. However, current 2008 congressional budget proposals include an increase to the NIH budget of 2.4% to 3.3%, which would be an improvement over recent budget increases.

Upgrades and Innovations Spur Purchases

Companies within this subindustry derive revenue from the sale of equipment, consumables, and services. Equipment sales have improved in 2007 following sluggish sales in 2005 and 2006, and S&P sees continued solid sales in 2008 as pharmaceutical end users effect required equipment upgrades and purchase new innovative products.

Loo notes that purchases of consumables are typically immune from budget constraints. Therefore, he believes companies whose revenue bases are comprised primarily of consumables will likely rise faster than equipment manufacturers. Consumables also typically carry higher profit margins than instruments, and equipment manufacturers are aggressively expanding product lines to increase sales of consumables. S&P sees consumable sales rising in the high single digits.

In S&P's opinion, companies that provide services to pharmaceutical and biotech firms should see significant growth over the next 12 to 24 months. Loo believes pharmaceutical and biotech firms will increase outsourcing of services over the next several years, as he thinks it increases efficiency and lowers costs, while minimizing the necessity to expand overseas operations and infrastructure. Also, most emerging biotech firms do not have infrastructure in place and must outsource some services. Beneficiaries of this trend, in S&P's view, will be contract research organizations that provide drug development clinical trial services.

So there you have it. The group's longer-term momentum is firm by S&P's analysis, and the group's overall fundamental outlook is positive, indicating that from fundamental and momentum perspectives, this subindustry index should continue to see strong price performances in the period ahead.

Industry Momentum List Update

Here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of subindustries in the S&P 1500), along with a stock with the highest S&P STARS (tie goes to the highest market value).

Subindustry Company S&P STARS Rank Price (11/16/07)
Coal & Consumable Fuels Peabody Energy (BTU) 4 $52
Commodity Chemicals Lyondell Chemical (LYO) 3 $47
Computer Hardware Apple (AAPL) 4 $166
Construction & Engineering Jacobs Engineering (JEC) 5 $78
Diversified Metals & Mining Freeport-McMoRan Copper (FCX) 2 $100
Education Services Career Education (CECO) 5 $31
Fertilizers & Agr. Chem. Monsanto (MON) 3 $94
Health-Care Services LabCorp (LH) 5 $70
Industrial Gases Air Products (APD) 3 $95
Internet Retail (AMZN) 2 $79
Life Sciences Thermo Fisher (TMO) 5 $58
Oil & Gas Equip. & Svcs. Schlumberger (SLB) 4 $93
Oil & Gas E&P Chesapeake Energy (CHK) 4 $38
Tires & Rubber Goodyear Tire (GT) 3 $27

Source: Standard & Poor's Equity Research

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