Sector Screener: two FTSE 100 stocks for defensive growth

Investors typically face a choice between companies that offer strong growth potential and firms that have defensive characteristics. Indeed, it is somewhat unusual to find a business with both attributes.

Defensive companies such as those in the utilities and tobacco sectors, for example, tend to have slow-growing profits. Meanwhile, cyclical stocks in sectors such as information technology offer strong growth potential but can be badly affected by an economic slowdown.

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Several firms in the Pharmaceuticals & Biotechnology sector, however, appear to offer a potent mix of both growth and defensive attributes. Indeed, having surged 74% higher over the past decade, versus a 25% rise for the wider FTSE 350 index, the sector has an excellent long-term track record. With global demographic changes ahead, it continues to offer investment appeal.

Growth potential

Demand for a wide range of healthcare treatments is set to rise over the long run as a result of continued global population growth. The United Nations (UN) forecasts that the world’s population will rise from its present level of approximately 8 billion to around 8.5 billion by the end of the current decade. It is then expected to continue its rise to reach in excess of 9.6 billion by 2050. Alongside this, the world’s population is ageing. While 761 million people were aged 65 years or older in 2021, the UN expects this figure to more than double to 1.6 billion by 2050.   

This combination of a larger and older global population means that the incidence of a wide range of non-communicable diseases such as cancer and heart disease is likely to rise. Indeed, the World Health Organization predicts that the number of new cancer cases recorded globally per year will increase from 20 million in 2022 to around 35 million by 2050.

Rising demand for a variety of drugs and wider treatment options means that pharmaceutical and biotechnology firms offer significant long-term growth potential. Alongside this, companies operating within the sector should benefit to some extent from an improving global economic outlook. Falling interest rates are set to have a positive impact on GDP growth, employment levels and wages that should improve access to treatment for a wide range of conditions.

Source SharePad. Data as at 17 September 2024. Past performance is not a guide to future performance.

Source SharePad. Data as at 17 September 2024. Past performance is not a guide to future performance.

Possible threats

Of course, Pharmaceuticals & Biotechnology sector incumbents are less dependent on the economy’s prospects than most FTSE 350 firms. After all, healthcare spending is generally regarded as being among the most staple of items for most governments and individuals when deciding how to apportion their capital. This means that firms operating within the sector are less likely to experience a sudden deterioration in their financial performance as a result of any future challenging economic outlook, compared with other industries that also offer strong growth opportunities.

This does not, however, mean that pharmaceutical and biotechnology stocks are risk-free. Their profits can be heavily reliant on the development of new drugs that only generate significant revenues while being temporarily protected from the threat of generics by patents. Following the expiry of patents, which typically last for 20 years, pharmaceutical firms need to have developed other new drugs to take their place as profits typically tumble once generic manufacturers are able to begin production.

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Furthermore, the exceptional past performance of the sector means that several incumbents now trade on extremely high market valuations. In some cases they offer little or even no margin of safety. This can suppress investment returns and equate to severe share price falls should their drug development pipelines prove to be less successful than anticipated.

Managing risk

Investors can reduce risk when investing in the sector by selecting firms that trade on fair market valuations given their long-term prospects. They can also identify companies with solid financial positions that are able to invest a sizeable proportion of their revenue in drug development. This means they are more likely to produce a worthwhile number of ‘blockbuster’ drugs over the long run. And by purchasing pharmaceutical and biotechnology stocks that have diverse portfolios, in terms of being focused on a wide range of therapy areas, they can further reduce overall risk.

In addition, investors may wish to focus on consumer healthcare firms that are members of the FTSE 350 Pharmaceuticals & Biotechnology sector. They produce well-known healthcare products such as pain relief and allergy medications that are sold by a variety of retailers and which typically benefit from strong brand loyalty. As a result, their business models are usually more akin to those of consumer staple firms. This means that they typically offer greater stability than pharmaceutical companies.

Past performance is not a guide to future performance.

Haleon

FTSE 100-listed Haleon (LSE:HLN) was formed via the demerger of GSK’s consumer healthcare division. The company produces well-known brands such as Voltaren, Panadol and Advil, with its share price having surged 23% since the start of the year. This compares favourably with a 13% rise for the FTSE 350 Pharmaceuticals & Biotechnology sector over the same period and is 13 percentage points ahead of the wider FTSE 350 index’s year-to-date gain.

Haleon’s strong share price performance means it now trades on a relatively high price/earnings ratio of 22. However, the company’s improving competitive position means it warrants a premium valuation compared with the wider stock market.

Over two-thirds of its brands either maintained or expanded their market share in the first half of its current financial year, while the company’s gross profit margin expanded by 170 basis points year-on-year, as it benefitted from pricing actions and productivity improvements. This contributed to an 11% rise in operating profits, which allows for greater investment in its diverse portfolio of brands.

With a debt-to-equity ratio of around 53%, the company has a solid financial position through which to overcome potential future economic turbulence. Its strategy of refreshing its portfolio via asset disposals means it is becoming better placed to focus on stronger growth areas that can have a greater impact on profitability. As a result, it offers further capital growth potential as its sound strategy and an improving trading environment catalyse its financial performance.

AstraZeneca

While Haleon produces a range of consumer healthcare products, fellow FTSE 100-listed pharmaceutical firm and currently the UK’s largest company, AstraZeneca (LSE:AZN) focuses on developing new treatments in areas such as oncology and rare diseases.

The company’s latest half-year results showed that revenue rose by 18%, with its improving financial performance providing scope to increase investment in its pipeline of new drugs. Indeed, research and development (R&D) expense continued to amount to 22% of revenue during the second quarter. Given the firm’s sales growth, this meant that R&D spending rose by 13% overall. This should equate to a stronger long-term financial outlook as the firm seeks to grow its top line by 75% by 2030 in response to rising demand across several of its key segments.

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A solid financial position means the firm is well placed to reinvest for long-term growth. For example, its net debt-to-equity ratio stood at 67% at the time of its recent half-year results. And with the company being exposed to a diverse range of therapy areas, it offers less risk than many of its pharmaceutical peers.

Having risen by 13% since the start of the year, AstraZeneca’s share price has outperformed both its sector and the wider FTSE 350 index. Its gain has contributed to a higher market valuation, with the stock now trading on a PE ratio of 19. While this is significantly higher than many large or mid-cap shares at present, the firm’s strong growth potential and solid financial position mean it still offers good value for money on a long-term view.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.