A Stockpicker on the Reshaping of Health Care

Eddie Yoon has emerged as one of Fidelity’s stars, as his Fidelity Select Health Care Portfolio fund produced 18.4% a year over the past decade, beating the average health-care mutual fund by 3.5 percentage points. In school, Yoon occasionally did his homework at his mom’s radiology office, and helped out at his dad’s dental practice. While Yoon’s older sister followed in his father’s footsteps, Yoon chose a different route. After graduating from college, he took a job at J.P. Morgan Securities, working for three analysts who taught him about health-care companies.

Yoon never looked back. His parents, originally perplexed by his career choice, are investors in his fund (FSPHX). “I like that existential drive within him and the fact that he is squarely focused on becoming the best of the best in health-care stock-picking,” says Jim Lowell, editor of Fidelity Investor and Fidelity Sector Investor.

We checked in with Yoon recently to ask him about the outlook for the pandemic, and how to navigate investing in one of America’s biggest sectors. Here’s what he said.

Barron’s: How is this crisis unfolding, now that states are reopening and the protests are likely to increase transmissions?

Eddie Yoon: The first stage was really getting through the epidemic peaks and flattening the curve. Hopefully, that’s in the rearview mirror. We need to be mindful of a potential second wave. The vigilance around testing helps us capture those waves before they become epidemic outbreaks like we saw in March. That’s Phase 1.

We’re in the early innings of Phase 2, or how we live in a world of coronavirus. You’re definitely going to see some underlying transmission because of the protests. We’ll know from testing data over the next two to three weeks how it pans out. When you watch the news, people are wearing face masks; it’s outdoors. We’ll learn about transmission dynamics in outdoor settings in large gatherings. If you look along the U.S.-Mexico border, you’re starting to see higher rates of transmission, which begs the question of how sensitive the virus is to warm weather. Viruses in general don’t like humidity.

Phase 3 will be herd immunity and vaccinating the entire world population. The goal of public health officials as we go through the summer is being mindful of potential hot spots that start going up on the infection curve, and preventing overwhelming the health-care system.

What happens in fall and winter?

The next flu season starts in the fourth quarter and goes into the first quarter. I’ve always been hopeful that herd immunity would be the end goal. Coronaviruses are relatively new to humans, so we don’t have a lot of natural immunity. We know of all the vaccine programs in clinical development. I’m hopeful that by this time next year, there will be a vaccine either on the market or about to hit the market that will have an impact on herding. We need hundreds of millions of doses. A lot of vaccine programs are being built on industrial-scale vaccine platforms, so that makes me hopeful.


Moderna
[MRNA] seems to be the leader in the race to a vaccine. Why don’t you own it?

There are over 300 publicly traded biotech companies, and if you look at my holdings as of the end of March, I own fewer than 50. That’s because when we invest in biotech, we’re trying to find something unique, durable, and differentiated. My level of conviction dictates which stocks go into the portfolio. It’s such a high risk/high reward area.

Where are the opportunities in health care now?

Obviously biotech is interesting, but people fail to realize that innovation in health care is so broad. You see it in medical technology, digital health, and health insurance. Health care in the U.S. is almost 20% of our gross domestic product. It’s pushing $4 trillion in total spend. About 15% is spent on drugs and 85% on other things: Hospitals, doctors, infrastructure.

Historically, the hospital was paid on a fee-for-service basis to address symptoms, perform surgeries, handle chronic conditions, etc. What’s unique at this moment is the reorientation of the health-care system, where the patient is now put at the center. The media talks about it as value-based care. For the first time ever, the incentives of the three biggest stakeholders—the payer, the provider, and the patient—are aligning. That creates a better consumer experience and can have a very profound effect in lowering health-care costs. It’s working in some local markets in Ohio, Florida, and Southern California. The trick is to get this to operate at a national scale. That is a long-run secular investment trend that’s early, and will create a unique investment opportunity over the next 10 years.


Hospital care is being pushed into the community.


— Eddie Yoon

Then there’s the innovative nature of digital health. Technology is really just beginning to have an impact on health care, and to create a much better consumer experience that’s actually going to be lower cost. The whole concept of verticalization, like when
CVS Health
[CVS] and Aetna came together in 2018, is because they’re trying to deliver a total cost-of-care solution to the marketplace. Covid-19 is accelerating that transformation.

What should investors avoid?

Fixed-cost businesses like hospitals are facing headwinds with the cessation of elective procedures. It also hurts the medical-device industry in the short run. Depending upon the duration of the coronavirus, I feel pretty confident that the return of elective procedures will be faster than other parts of the economy. They’re medically necessary. I don’t have any investments in health-care facilities, hospitals, or labs. Hospital care is being pushed into the community. An outpatient visit might turn into a televisit. Reimbursement is lower. With unemployment going up, people are losing health insurance. They’re going on Medicaid. When you turn 65, you become Medicare eligible. The government payers reimburse at a lower rate, generally, than commercial insurers.

This is an election year, which in the past has been significant for the sector. What are the political risks?

We all know that demographics are getting older and people are getting sicker, and we need to figure out how to treat people at lower costs. The biggest health risk right now is elective surgeries on hold, so coming out of this are chronically ill patients who haven’t been seen by their health-care professionals [during the pandemic]. The fundamental problems that our health-care system faces are an access problem and a coverage issue. Whether you’re a Republican or Democrat, you want to expand access points and ensure that the health-care system is strong enough to handle future pandemics. If you focus on investing in companies driving productivity, efficiency, and a better consumer experience, that should be a winning solution regardless of the policy environment.

Will supply chains change as companies return to globalization?

A lot of supply chains will come back to America because of coronavirus. You’ll start to see some of the higher-tech manufacturing plants built in the U.S. How that impacts gross margins will be more incremental than material. The lower margin products will be impacted more.

How are your holdings growing?

We have a free-cash-flow per share framework that spits out a price target valuation. The riskier the investment, the higher the return opportunity has to be. The large-cap multinationals can compound earnings, hopefully, in the double digits over time. If you buy them at the right price, you might have multiple expansion, so you get paid twice. As long as they’re not superexpensive, they’re going to stay in the top of the portfolio, because I believe in the durability of that group. Going down the portfolio, the variability of the cash flows becomes more uncertain. Twelve years ago, I said to my chief investment officer, I want to deliver a 10% return experience over the next 10 years, and that should outperform the benchmark in that underlying asset class. Health care relative multiples are cheaper than they’ve been historically, by a wide margin. In 2019, health care was one of the few big sectors that grew earnings. Tech was the No. 1 sector, but it was almost entirely multiple expansion.

Let’s talk about some of your large positions.
AstraZeneca
[AZN] has a potential Covid-19 vaccine.

The thesis behind Astra isn’t related to coronavirus. Pharma companies are obviously highly profitable but go through patent cliffs in which they lose multibillion-dollar profits. When most companies go through a patent issue, they try to cut costs, protect their profitability. Over the past six years, Astra invested through its patent loss. You’re starting to see its pipeline come to fruition. In the portfolio top 10, you see Astra,
Roche Holding
[ROG.Switzerland], and
Eli Lilly
[LLY]. They have really innovative pipelines that are starting to produce commercial drugs that will drive the next several years’ performance. Look at Astra’s cancer franchise. At the American Society of Clinical Oncology’s annual conference, we saw great data in its oncology pipeline for Tagrisso, one of its key drugs. It is a highly innovative asset going to a very large marketplace. Astra has its own PD-1 immunotherapy program. Both will drive revenue growth.

There’s huge turmoil in the employer-based market right now. What do you like about
UnitedHealth Group
[UNH]?

Earlier we talked about the economic incentives of the payer, provider, and the patient all coming together. A company like UnitedHealth enables that new business model through its Medicare Advantage plan, through its employer-sponsored health insurance. It is trying to get employers to start figuring out how to treat their employees in their preventative stages of chronic disease, before they become acute chronic issues. The longer you can keep people in a preventative phase, the lower the cost for the system and to the employer. In its Medicare Advantage business, it’s bringing food and delivering medicines to seniors in their homes, which reduces their risk of getting exposed to the coronavirus and keeps them out of the emergency room. In the Optum business, it’s saving costs with telemedicine, which can prevent an ER visit. United is strategically well positioned to take advantage of that whole verticalization of the health-care ecosystem. It was first to the game. It does health analytics. It has Optum care. It has a pharmacy-benefit manager. It has an insurance business. The long-term savings will be amazing.

Let’s talk about a company with a promising treatment.

I don’t love talking about single stocks. I don’t want to jinx myself.
Regeneron Pharmaceuticals
[REGN] has a strong, stable base business in Eylea, its age-related macular degeneration drug. It doesn’t grow very fast, but generates a lot of cash for the company. It has Dupixent, a superinnovative drug for atopic dermatitis with annual revenue of about $2 billion. It’s partnering with
Sanofi,
and the partnership just turned profitable. On top of that, Regeneron has an amazing antibody platform that was the engine that discovered the tumor marker drugs. It has the potential to not only discover new cancer drugs and new autoimmune drugs, but also to hopefully discover a neutralizing antibody for the treatment of coronavirus. We’ll know with a fair degree of certainty when it releases data in the second half of this year.

Let’s talk about
BioNTech
[BNTX], a messenger RNA company like Moderna.

BioNTech is partnered with
Pfizer
on a coronavirus vaccine program. We owned it as a private investment, and now it’s public. Its vaccine program is not far behind Moderna’s. It also has an mRNA cancer program that is ahead of Moderna’s. These time lines are publicly disclosed. Moderna’s market cap is two times that of BioNTech. And we’re going to start to see very important clinical data over the next 12 to 18 months. It’s obviously in the high risk/high reward category.

Thanks, Eddie.

Write to Leslie P. Norton at leslie.norton@barrons.com