The Healthcare Sector

1
The Healthcare Sector

• November 25, 2003

• Healthcare Team
• Josh Dritz
• Ribhe Elsalaymeh
• Matthew Endress
• Corey Jansen
• Aasim Khwaja
• Matt Titus
• Colleen Zaczek

2
Agenda

• Current Situation
• SP Breakdown
• The Sector Clock
• Investment Recommendation
• Names to be Reduced
• Cardinal Health, Inc. (CAH)
• Johnson and Johnson (JNJ)
• Conclusion

3
Current Situation

• Current SIM weighting (September 23, 2003)
• 16.54 of SIM portfolio
• Overweight by 2.89
• Recovery warrants a move away from defensive
  stocks
• As a growth investors we put a greater weight on
  slowing growth rate than the undervalued status
• Recommend moving to a 1 underweight for the
  overall sector

4
SP Breakdown Sub-sector Weights
Pharmaceuticals dominate Four sub-sectors
account for more than 90 of the Healthcare sector
Data as of October 31, 2003
5
The Sector Clock
The time is 400 for the Healthcare Sector Cheap
without catalyst
6
Investment Summary

• We recommend maintaining current positions in the
  following stocks
• AmerisourceBergen (ABC) continuing earnings
  growth due to additional efficiencies gained from
  merger as well as increased demand for
  pharmaceuticals due to Medicare Bill
• Amgen Inc. (AMGN), Medtronic (MDT) Biotech
  offers continued growth potential due to
  proprietary technologies and pioneering attitudes
  of the firms in this sector
• UnitedHealth Group (UNH) overall windfall
  expected for HMOs due to Medicare bill which
  increases payments for all groups
• Pfizer (PFE) demographics strength, Medicare
  bill, bigger gains from efficiencies in the
  supply chain than competition, and merger
  synergies
• We recommend reducing holdings in the following
  stocks
• Cardinal Health, Inc. (CAH)
• Johnson and Johnson (JNJ)

7
Cardinal Health, Inc. (CAH)

• Global healthcare services company focused on
  wholesale drug distribution with diversified
  businesses in other areas of healthcare
• Medical Products and Services
• Automation and Information Services
• Pharmaceutical Technologies and Services
• Current Position -- 4.67 of the SIM portfolio
• Recommended Position 2.36 of the SIM portfolio
• Reasons to Keep
• Solid company
• Defensive position is still important
• Most diversified of competition with high margin
  components (AIS, PTS)
• Reasons to Sell
• Continuing pressures on wholesale distribution
  margins and overall business model
• Major contracts up for bid
• Price pressure on suppliers

8
Cardinal Health, Inc. (CAH)

• Trend indicates that CAH may not be able to
  outpace the overall Healthcare sector for much
  longer

9
Cardinal Health, Inc. (CAH)

• P/E ratio still attractive, supporting keeping
  the stock in the portfolio with reduction in
  overall investment weighting

10
Cardinal Health, Inc. (CAH)

• ROE has maintained consistent level
• Margin is better than competition and improving
  due to diversification into more profitable
  sectors of the market

11
Cardinal Health, Inc. (CAH)

• Slowing net income growth
• Buy margin opportunities in wholesale drug
  distribution business are going away
• Sell margin in wholesale drug distribution is
  non-existent

12
Johnson and Johnson (JNJ)

• Global manufacturer of healthcare related
  products pharmaceutical, surgical equipment,
  and consumer health products
• Current Position 1.58 of the SIM portfolio
• Recommended Position 0 of the SIM portfolio
• Reasons to Sell
• Pharmaceutical business the key driver of sales
  and EPS growth over the past several years has
  begun to moderate due to patent expiration and
  launch of competitor products
• Medical device competition (stents) is
  threatening the margins on JNJs highest margin
  product line

13
Johnson and Johnson (JNJ)

• Moderately valued relative to the sector with in
  line growth (there are higher growth stocks in
  the portfolio at lower P/E ratios)

14
Johnson and Johnson (JNJ)

• Concerned about growth rate trends due to supply
  constraints and competition from BSX (stents) and
  others

15
Johnson and Johnson (JNJ)

• Current value of the stock includes current
  trends in operating margins and ROE
• Competition and patent pressure put future growth
  of these measures at risk

16
Johnson and Johnson (JNJ)

• Inventory rise is concerning given industry-wide
  changes in distribution trends need to cut
  production to get that product into the channel
• Long-term debt is of interest

17
Johnson and Johnson (JNJ)

• Would have expected Gross Profit to grow at a
  faster rate due to Stent sales which is not
  evident here

18
Conclusion

• Several sub-sectors of the Healthcare portfolio
  remain attractive
• External factors continue to point to top and
  bottom line growth
• Competition from generics and weaker pipeline
  threaten growth potential of the Pharma space
• Demographic drivers already reflected in stock
  prices of many sub-sectors
• Overall reduce holdings to capture recent gains
  and fund move toward higher growth stocks as
  economy recovers and B2B spending increases