Healthcare Sector Student Investment Management Analysts: John Laliberte Andrew Jasen Zach Janszen 11/1/2016

Overview 3rd largest sector in the S&P 500 13.40% of the index $1.7 Trillion in revenues annually Over 17 million employees in US Over 750,000 US companies Industry Vertical   Market Cap ($Bn) 1 Year Return Pharmaceuticals $1,980.0 (6.3%) Biotechnology 825.1 (11.2%) Supplies & Equipment 676.4 17.0% Providers & Services 613.4 2.0% Life Sciences 187.4 8.7% Technology 49.1 (8.9%)

Companies Companies Market Cap ($Bn) Johnson & Johnson $316.3 Pfizer   Market Cap ($Bn) Johnson & Johnson $316.3 Pfizer 189.08 Merck 155.88 UnitedHealth Group 133.09 Medtronic 113.35 Amgen 95.51 Gilead 94.67 AbbVie 85.13 Allergan 84.51 Bristol-Myers Squibb 83.51

Performance Recent underperformance Long-term outperformance Buying opportunity?

Business Analysis Defensive industry – Demand for healthcare products is inelastic. People will give up a lot before healthcare. Much less affected by economic downturns than other industries. International IP enforcement serve as potential catalyst for pharma/distributor growth.

Business Analysis Continued - Demographics The two largest generations ever are the Baby Boomers (74.9 million) and the Millennials (75.4 million) Baby Boomers are reaching retirement age (currently 52-70 years old) Millennials are approaching the age of bearing children (19-35 years old)

Five Forces Analysis Supplier Buyer Ease of Entry Substitutes Providers have high bargaining power Few suppliers relative to number of buyers Buyer Weak consumer power due to inelastic demand Ease of Entry High regulation Quasi-capital intensive and IP related High M&A activity Substitutes Low due to IP prevalence Lack of coverage options Competition Intense Dominated by large companies

Raw beta shows there it is a defensive industry Adjusted beta is even closer to 1, even closer to the market, which further shows the industry’s close relationship to the overall market

Healthcare follows the S&P pretty closely, but due to the lower beta, large fluctuations in the overall market will not move the healthcare index as greatly

Healthcare performance plotted against US population – further shows that this industry will benefit tremendously from an increasing population and retiring age group (millennials and baby boomers are largest population groups)

Economic Analysis Cont. Rising premiums driven by ACA Current low interests hurt insurers and savers, but help pharma, med tech, and distributors Political uncertainty Trump: repeal ACA, maintain pre-existing conditions Clinton: “fix” ACA, possible government controlled competitor Little impact in short term Report Monday, the 24th: Premiums expected to rise 22% next year under ACA, but 77% of people enrolled under the plan will be able to pay $100 or else a month taking subsidies into account Patients in ACA are sicker, more expensive, and seek more medical care

Financial Analysis

Valuation Overview S&P 500 Health Care Sector Index (S5HLTH) - Valuation Overview   12/31/2009 12/31/2010 12/30/2011 12/31/2012 12/31/2013 12/31/2014 12/31/2015 10/26/2016 12/31/2016 12/31/2017 Valuation Metrics Price/Earnings 13.0x 12.0x 12.2x 14.8x 20.0x 23.0x 21.8x 19.5x 15.5x 14.1x Price/Book Value 2.4x 2.5x 2.7x 3.5x 4.1x 3.9x 3.6x 3.4x 3.1x EV/Sales 1.3x 1.2x 1.4x 1.8x 2.0x 1.7x EV/EBIT 10.5x 9.8x 12.1x 17.2x 18.8x 19.2x 17.3x EV/EBITDA 8.1x 7.5x 7.6x 8.8x 14.2x 13.1x 10.8x 10.1x Dividend Yield 2.0% 2.1% 2.2% 1.6% 1.5% 1.7% 1.8% 1.9% Fundamentals Gross Margin 33.9% 34.3% 34.4% 33.5% 32.6% 32.7% Operating Margin 12.5% 12.1% 12.3% 11.7% 10.6% 10.4% Profit Margin 9.6% 7.3% 7.6% 8.3% 7.9% 7.4% 7.8% Return on Assets 9.7% 7.0% 6.7% 7.1% 6.3% 6.5% 8.4% Return on Equity 22.0% 15.4% 16.4% 15.7% 17.6% 17.2% 16.6% 16.9% 25.3% 27.2% Sharp drop off in earnings multiples with a simultaneous constant in EV/sales shows that the industry as a whole is developing and maturing – their earnings per share are increasing against a more stagnant sales figure which show that the industry is not in a typical growth stage when it seems to be focusing on margins and operations all with a slight turnaround in 2015

Valuation Over Time S&P P/E 24.3x P/E 19.4x P/FCF 17.0x EV/EBITDA S&P EV/EBITDA 14.1x The healthcare index is undervalued relative to the S&P on an earnings and enterprise basis This makes sense given the healthcare market’s fundamentals, low beta, and defensive nature – this little underperformance on a valuation perspective actually surprised us as we expected the enormous bull market that the US entered after the financial crisis would push market valuations much higher (one explanation could be M&A premiums priced into the stocks as this sector has been one of the most active)

Valuation Relative Valuation YTD S&P High Median Low Current P/E   S&P High Median Low Current P/E 20.51x 19.18x 17.10x 20.11x P/B 2.53x 2.79x 2.88x 2.81x P/S 1.95x 1.87x 1.67x 1.92x EV/EBITDA 13.25x 12.54x 11.43x 13.13x S5HLTH 22.45x 20.60x 19.40x 19.04x 3.89x 3.70x 3.46x 3.54x 1.72x 1.62x 1.65x 14.72x 13.65x 12.91x 13.07x Delta  (Healthcare Index – S&P) 1.94x 1.42x 2.30x (1.07x) 1.36x 0.91x 0.59x 0.73x (0.08x) (0.14x) (0.06x) (0.27x) 1.47x 1.11x 1.48x P/E   Sep-16 Jun-16 Mar-16 Dec-15 Sep-15 Jun-15 Mar-15 Since 2015 Large Pharma 19.7x 23.8x 24.6x 21.2x 16.4x 14.0x 13.3x 6.4x Manged Care 19.6x 22.8x 21.6x 21.4x 18.8x 21.1x 20.4x (0.8x) Hospitals 14.2x 14.6x 13.6x 12.9x 13.9x 17.6x 15.1x (1.0x) Biotechnology 21.3x 24.8x 26.4x 34.4x 20.6x 17.5x 16.5x 4.7x Supply Chain 18.3x 18.6x 16.9x 20.2x (0.0x) Medical Devices 22.9x 19.9x 21.0x 18.5x 3.0x EV/EBITDA 11.5x 9.1x 7.9x 8.3x 5.0x 7.1x 6.9x 6.1x 5.8x 4.1x 1.3x 7.4x 7.2x 7.3x 9.5x (2.1x) 17.0x 17.8x 22.7x 13.7x 11.1x 5.9x 10.0x 10.6x 9.4x 11.7x 10.2x (0.2x) 14.4x 12.1x 12.6x 11.0x 13.1x YTD – on an earnings basis, the general market is outperforming the healthcare sector due to future uncertainty within healthcare – HC companies are still figuring out how to navigate the political landscape

Recommendation Risks Strengths Current SIM portfolio: Recommendation: Political uncertainty and drug pricing Rising premiums Strengths Defensive, inelastic demand Strong demographics Favorable valuations Current SIM portfolio: Healthcare: 13.44% as of 9/30 S&P500 Healthcare: 14.68% as of 9/30 Recommendation: OVERWEIGHT Moving forward the market uncertainty will push investors toward more defensive stocks – a lot of these companies like we stressed earlier are experts at commercialization and monetization for products or services with generally inelastic demand Global volatility will just further help this sector and the flight-to-safety of capital allocated toward equities will go to stocks in sectors like healthcare There is relative undervaluation in the sector coupled with favorable growth driven largely by demographics – therefore, overweight this sector moving forward [In addition to the stated risks and strengths]

Questions?