While investing in any company carries risk, some are riskier than others. And with the healthcare sector being viewed as a more defensive sector than many of its industry peers, many investors have bought stocks such as CSL Limited (ASX: CSL) and Cochlear Limited (ASX: COH) with the idea that they will be more resistant to the challenges facing the economy than most stocks.
Business model
However, CSL may not be quite as low risk as many investors believe. That's partly because of its business model, with CSL's long term profitability being reliant upon R&D and the ability to bring new treatments to market. This means there is a risk that CSL's R&D fails to deliver sufficient treatments to boost the company's profit, which could hurt its share price performance.
Unprofitable division
Further, CSL's acquisition of Novartis' influenza vaccine business may provide significant long term growth opportunities, but the unit which is now named Seqirus remains unprofitable. Therefore, it is likely to require both time and investment to come good. Although I believe it will, losses in one division will need to be offset by strong growth elsewhere.
Low positive correlation
Despite this, I believe that CSL continues to be a much lower risk stock to own than the vast majority of its ASX peers. It may be dependent upon the success of its R&D programme, but its low positive correlation with the economy should help shield it (and its investors) from the ups and downs of the economic and business cycles.
Strong finances
Further, CSL has excellent cash flow which means it can afford to invest heavily in R&D. For example, its net operating cash flow in each of the last two years has been over US$1.3 billion and this has allowed it to build a research team numbering over 1,100 people and to spend over US$2 billion on R&D over the last five years.
Meanwhile, its modest debt levels mean that further acquisitions are very much on the cards, should its treatment pipeline fail to deliver the desired levels of organic growth. For example, CSL's net debt to equity ratio is just 63%, versus 154% for healthcare peer Ramsay Health Care Limited (ASX: RHC). This indicates that more balance sheet risk can be taken in the case of CSL, while its interest coverage ratio of 30 provides more evidence that this is the case.
Low beta
In addition, CSL's beta is only 0.6. This means that its shares should theoretically move by 60% of the amount of the ASX in the short run. This should provide reduced volatility for CSL's investors and boost its defensive credentials since it could significantly outperform a falling wider market.
Growth potential
While CSL's P/E of 30 indicates that it lacks a wide margin of safety and many investors may feel that this makes it relatively risky, CSL's forecasts show that it may in reality be undervalued right now. According to Morningstar it is due to increase EPS by 24% next year, which may act as a further catalyst on its share price.
