PPH: A Pharmaceutical ETF Delivering Close To 10% Total Return

VanEck Vectors Pharmaceutical ETF (NASDAQ:PPH) is a healthcare exchange traded fund (ETF) launched and managed by VanEck Associates Corporation. The fund invests only in 25 large-cap major pharmaceutical companies that are included in the MVIS US Listed Pharmaceutical 25 Index (MVPPHTR). This non-diversified pharmaceutical ETF was formed on 1st February 2000, more than 21 years ago.

VanEck Vectors Pharmaceutical ETF is a small-sized fund with net assets of $386 million, most of which (64 percent) is invested in equity shares of US-based companies. This ETF has invested 3 percent or more in 20 companies, which constitutes 92 percent of its total portfolio. This implies most of its investments have a significant impact on the performance of this ETF.

VanEck Vectors Pharmaceutical ETF has invested more than five percent of its total portfolio in seven stocks – AstraZeneca PLC (ANZ), Eli Lilly and Company (LLY), AbbVie Inc. (ABBV), Novo Nordisk A/S (NVO), Bristol-Myers Squibb Company (BMY), Pfizer Inc. (PFE), Merck & Co., Inc. (MRK). All these seven stocks together account for around 36 percent of its total investments.

Historically, VanEck Vectors Pharmaceutical ETF has generated a total return of around 10 percent. In the past 21 years of its existence, its annual average return was 10.36 percent. In the past 3 years, 5 years and 10 years, this fund has generated an average annual return of 11.5 percent, 9.7 percent and 9.8 percent, respectively. Past one year’s return has been exceptionally good at 17.5 percent. Incidentally, the return of this fund has exceeded the return of its benchmark index throughout these years.

VanEck Vectors Pharmaceutical ETF generated an average yield of a little less than two percent in the past 10 years. So, the price growth had ranged around 8 to 10 percent over these years. Such a price growth over a longer period of time is decent enough to attract growth-seeking investors. However, such low yield will not be suitable for income-seeking investors.

VanEck Associates Corporation has separate ETFs for the Biotechnology and Pharmaceutical sectors. A comparison of PPH with VanEck Biotech ETF (BBH) clearly reveals the growth pattern in these two major healthcare sectors. While BBH’s total return was negative 7.5 percent during the past one year, its total return over the past three and five years has been 8.4 percent and 6.8 percent, respectively. However, in the long run, BBH’s return beat that of PPH. BBH recorded an average annual total return in excess of 14 percent over the past 10 years.

Considering the fact that pharmaceutical stocks have performed poorly after the pandemic period, PPH’s growth rate in the short and medium term is much higher than I would have expected. A closer look at PPH’s top 20 holdings (which constitutes 92 percent of its portfolio) reveals that half of these stocks have performed extremely well.

In addition to the top seven holdings (more than 5 percent of total investments) mentioned above, McKesson Corporation (MCK), AmerisourceBergen Corporation (ABC), and Zoetis Inc. (ZTS) have matched or outperformed PPH’s return both in the past one year and five years. Together, these stocks account for half of this ETF’s investment and generated an average price growth of 46 percent and 143 percent over the past one year and five years, respectively. Unfortunately, the other 50 percent holdings of this pharmaceutical ETF was not that productive.

The companies included in PPH’s portfolio of investments have generated strong earnings growth of 26.5 percent, P/E of 10.7, Price/Book of 2.7, and Price/cash Flow of 9.5, which suggests that this ETF is undervalued. Price multiples are considerably lower than its peers and index despite such strong earnings and stable historical price growth.

A probable reason for such undervaluation might be the poor average sales (6 percent) and cash flow growth (5.1 percent) of these large pharmaceutical companies. Another demotivating factor might be the proposed prescription drug deal. This deal favored, by the Democrats, and also having some acceptance among Republicans, if implemented, will have some negative impact in the short run.

The prescription drug deal, which is a $1.85 trillion social safety net plan, will allow the US government to negotiate drug prices covered by Medicare, the federal health insurance program for people 65 or older and for disabled people. “Starting in 2023, negotiations could begin on the most expensive drugs – treatments for cancer and rheumatoid arthritis, as well as anticoagulants. Most drugs would still be granted patent exclusivity for nine years before negotiations could start, and more complex drugs, called biologics, would be protected for 12 years”.

VanEck Vectors Pharmaceutical ETF is already trading very close to its 52-week high of $84.27, which was recorded on last Friday, April 8th, 2022. The price is in a downward trend now, and it may fall down further in the coming days. But, that might be a very short-term phenomenon. The short-term simple moving averages (SMA) are placed significantly higher than the long-term SMAs, which implies that the stock is expected to rise even in the short term. As on 13th April 2022, 200-day SMA (75.39), 100-day SMA (76.3), 100-day SMA (77.6), and 10-day SMA (81.43) are exactly in sync, which can indicate the beginning of a steady bull run.

Pharmaceutical sector, in general, has performed poorly during 2018 (due to higher tariff, interest rate hikes, and tax cuts) and 2020 (due to Covid-19 pandemic). Despite this, PPH has been able to generate close to double-digit total returns over the past five years. The sector has shown strong signs of recovery post-pandemic. In general, the pharmaceutical sector is poised for high growth in the medium and longer term.

As the world can’t do away with pharmaceutical products – be it essential and lifesaving medicines, general medicines or preventive medicines, pharmaceutical companies will always be on a growth trajectory. The large-cap companies in PPH’s portfolio will immensely benefit out of this.

The prescription drug deal act poses a threat for the big pharma industry. However, the pharmaceutical industry is becoming habituated with these things; there’s some industry-wide problem here every four or five years. The big pharma companies thus witness some poor growth years in between steady returns. Therefore, it will be wise to stay invested in this ETF for a longer period of time. I believe this superbly boring ETF is an excellent choice for risk-averse investors.