Hospira hits the jackpot

If you've read our research over the past four years, or perhaps our regular articles in the Sydney Morning Herald, you'll know we've been strong proponents of diversifying overseas.

As China's growth is slowing, commodity prices, the Aussie dollar and local interest rates are falling. The strong performance of US stocks in particular has produced fantastic returns for those that shared a similar disposition and acted on it.

While you would've done well by simply buying an index fund and enjoying the currency gains, we used the same process that's served us well for the past 15 years to select many overseas stocks, culminating in the recent launch of our Premium Share Advisor service, which aims to take advantage of opportunities outside our shores.

One of the opportunities we highlighted fifteen months ago was US-listed company Hospira. You can read the original article below, but in summary the business's manufacturing facilities had fallen foul of regulators and required a large investment to bring them up to standard.

The market seemed not to care that the company occupied the 'privileged position as the world's largest producer of generic injectable pharmaceuticals'. Think sitting in a hospital bed hooked up to a drip to give you the medicine you need to fight various ailments.

A new chief Mike Ball had also been installed to deal with the US Food and Drug Administration (FDA) and was making progress. Remarkably, Hospira had been able to maintain sales since Ball's arrival despite one of its largest facilities (accounting for a quarter of the company's sales) running at only 60% of capacity.

The stock also had a huge growth opportunity should the biosimilars market – biosimilars are copycat versions of biological medicines that have already been authorised for use – in the US open up, like it had in the Europe and Australia. Still, the stock price lumbered.

As the FDA issues have faded away the stock price increased to $60 over the past year, until rocketing to $87 late last week after Ball announced a takeover offer from pharmaceuticals giant Pfizer.

After suggesting that 'For such a fast-growing company free from regulatory problems, Mr Market or a suitor might be prepared to pay a multiple of 20, which could see the stock double or more', it was great to see an opportunity work out so well and so fast. Rarely is investing so satisfying, though there is a chance shareholders would do better over time if the company were left to its own devices.

So what lessons can we learn from this experience?

1. First, investing abroad isn't as difficult as many would have you believe. If you apply the same principles that you do to local stocks, be patient and only invest in businesses that you understand, by fishing in bigger pools you're more likely to find a hidden gem.  
2. At $40 per share Hospira was about a $6bn business. For large funds this constitutes a small cap stock, yet in Australia it would be one of our largest blue chip stocks exhibiting all the features that we love about hugely successful healthcare businesses such as CSL, ResMed and Sonic Healthcare, just to name a few.
   There are only so many great healthcare stocks in Australia, so looking abroad can increase the chances of finding one of these great businesses at a cheap price. 
3. Many investors are asking whether it's too late to invest overseas given the Aussie dollar's rapid descent. The answer is no, provided you can find cheap stocks overseas where the potential gains aren't likely to be wiped out by currency swings. Often a stock is so cheap that you'll still do well even if the currency doesn't go in your favour. And just because the Aussie dollar is back around its long-term average doesn't mean that's where it will stay. It fell to almost 60 US cents during the GFC and we didn't even have a recession. Imagine what it could fall to if China's economy or our housing market cracked.

There are many other lessons that you could draw from this experience, but when you read that only around 1-2% of SMSF assets are invested overseas despite the risks facing the Australian economy, the most obvious one is that if you're not considering investing abroad then it's not too late.

Too many Australian portfolios are over-exposed to banks and resources companies, as they represent about half of the major indexes. Worse, though, is that the same people that can least afford to suffer large losses are likely the ones most exposed to these highly cyclical businesses, not just by owning banks directly, for example, but through their super funds, direct property holdings and the hybrid securities that the banks are issuing like confetti because investors are preoccupied with yield than objectively assessing the risks.

We hope to find many more Hospira's at home and abroad in the years ahead. Even in bull markets there are cheap stocks, you just need to know how to find them.

Hospira (NYSE—HSP $40.43)

'Face up to two unpleasant facts' warns Warren Buffett, 'The future is never clear, and you pay a very high price in the stock market for a cheery consensus. Uncertainty is the friend of the buyer of long-term values.'

Right now most investors wouldn't touch Hospira with medical gloves, despite its privileged position as the world's largest producer of generic injectable pharmaceuticals that are chiefly used in hospitals to manage pain and regulate fluids and medication. The company was spun out of US-listed healthcare giant Abbott Laboratories in 2004, and you may recall Hospira acquiring local pharmaceutical company Mayne Pharma in 2007.

In late 2011 the company's share price was cut in half after it received warning letters from the US Food and Drug Administration (FDA) for manufacturing defects and quality control issues. According to Eric Palmer of FiercePharmaManufacturing: 'The company has had to recall a whole range of products in the last couple of years for everything from overfilled cartridges of pain drugs to vials containing glass particulate and steel and hair discovered in solutions.'

In 2011 Mike Ball was brought in as chief executive to deal with the FDA and clean up the company's act. Remarkably, Hospira has been able to maintain sales since then, despite one of its largest facilities (accounting for a quarter of the company's sales) running at only 60% of capacity.

Having spent hundreds of millions of dollars upgrading several manufacturing facilities, the company is making progress, and over the next few years it should be able to increase earnings dramatically, helped by new products, new markets and acquisitions.

The company is currently expected to produce earnings per share of around $2, giving a price-earnings ratio of 20. But if it can capitalise on the numerous opportunities spelled out in Broyhill Asset Management's presentation once the facilities are fully operational, it could conceivably produce earnings per share beyond $4. For such a fast-growing company free from regulatory problems, Mr Market or a suitor might be prepared to pay a multiple of 20, which could see the stock double or more.

With earnings depressed and most investors waiting on the sidelines until the FDA endorses the company's facilities, Hospira offers plenty of upside with correspondingly low downside should the company's problems prove intractable, which seems unlikely given its recent progress, new management and multiple opportunities to increase sales.

Disclosure: The author, Nathan Bell, owns shares in all four companies. First published online 31 Oct 2013.