Three overlooked – but attractive – market sectors

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In order to boost ratings, financial media tend to focus on companies and industries considered “trendy”. The result is an endless stream of stories on the biotech and social media sectors, for example, and intense coverage of widely-followed names like Apple, Facebook and Alibaba. However, other market sectors can perform equally well over time, but typically receive little notice. We’d like to highlight a couple such sectors here, along with some of the companies we think deserve not only greater investor attention, but higher valuations as well.

Aerospace: Production data indicate that the industrial sector of the U.S. economy has been in recession since around Labor Day of last year. Results for the aerospace segment of the industrial sector have held up better, however. Revenue, profit and the profit-margin growth for aerospace suppliers such as Boeing (BA), Honeywell (HON) and General Electric (GE) have continued to be robust. This is because, according to the International Air Transport Association (IATA), commercial air traffic worldwide continues to grow at rates about double real Gross Domestic Product (GDP). When people reach the middle class, research has shown that one of the first things they like to do is travel, with much of this travel done internationally. As a result, flight hours are in a secular growth trend, and this trend should last for many years. Boeing CEO Dennis Muilenburg recently pointed out that there is one commercial airliner for every 500,000 Chinese citizens, versus one for every 50,000 Americans. Obviously this 10X difference won’t disappear in a year or two (or even 10!), but the demographic and economic winds are blowing strongly in favor of these aerospace suppliers.

Insurance brokerage: If you’re a business person of any kind, and need insurance coverage for risks involving health, property, casualty, etc., chances are you need to work with an insurance broker. This traditionally fragmented industry is consolidating at a rapid rate, and we own two of the companies driving the consolidation:  AJ Gallagher (AJG) and Marsh & McClennan (MMC). Each of these companies is consolidating both domestic and overseas markets. AJ Gallagher recently made two large purchases of agencies in Britain and Australia, with more small deals still to come. Historically, commercial insurance pricing has been very cyclical, with a decade of soft markets followed by a year or two of very large price increases. This cyclicality has been reduced in recent years, mostly due to the long term decline in interest rates. The brokerage business tends to be steadier, and the aforementioned consolidation provides the opportunity for growth for each of these companies.

Biosimilars: In the simplest terms, biosimilars are the generic version of biologic drugs. Up until the late 1980s, drugs were made from “inert” chemical compounds, rather than living tissue. A biologic drug is manufactured in a living organism – either a plant or animal cell. Most biologics are therefore very complex molecules. Many biologics are produced using recombinant DNA technology, and most are manufactured through chemical synthesis, which means they are made by combining specific chemical ingredients in an ordered process. Examples of biologics include Epogen, an anemia treatment, and Humira, a treatment for rheumatoid arthritis.

When patent protection runs out on these biologic drugs, the opportunity to produce a biosimilar arises. Biosimilars are not exact copies, because no two living cell lines (used as the starting point for manufacture) can ever be identical. But they are close enough where it matters, in terms of both therapeutic efficacy and side effects. Importantly, unlike generics, biosimilars must go through a very rigorous FDA-monitored manufacturing and approval process, which makes them quite difficult and expensive to produce. Not as expensive as developing a new biologic from scratch, obviously, but close. More and more of these biosimilars are being approved around the world, and we think there is a great opportunity for companies such as Amgen (AMGN) and Pfizer (PFE), who have the manufacturing expertise, to profit from these early approvals.

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