Pharmaceuticals and Big Oil are great sectors for the kind of long-term investment that ISAs are perfect for. It’s generally better to put the tax-wrapper of an ISA around funds that you plan to leave to grow the longest.
Pharma is a good sector because it is both defensive and a play on demographics in the West and East. Fierce opposition to any threatened cuts in the NHS budget demonstrate how protective people are of health services even in times of austerity. A good slug of the money that flows into healthcare ends up in the coffers of the drug companies — in bad times as in good. That’s what makes a defensive investment.
Demand for drugs will rise and rise. In the West the baby-boomers have become the grey vote, living longer and demanding new treatments to keep them healthy in old age. In emerging markets the rise of a wealthier and more-demanding middle class will fuel spending on healthcare.
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The oil sector is out of favour after the precipitous plummet in oil prices. That, for me, is precisely the reason to invest in it now. “I bought Shell (LSE: RDSB) (NYSE: RDS-B.US) when oil was $50″ might not prove to be as big a boast as “I bought Microsoft/Amazon/Google for $1″, but then it’s not such a big risk either. There’s a good chance of mean-reversion, i.e. the operation of market forces, pushing up oil prices eventually. But in any event Big Oil will adapt to the market conditions that prevail over its long-term planning horizons.
Top-down
If you adopt that top-down approach to investing, then the LSE gives you a choice of two big players in each sector. Diversification is a great thing so it can make sense to ride both horses – but for my money there’s a clear winner in each industry.
GlaxoSmithKline (LSE: GSK) has a robust business model, with lower-risk consumer healthcare and vaccines adding ballast to its patent drugs business. GSK’s scale is a big competitive advantage, enabling it to spend heavily on R&D as well as giving it marketing fire-power. The company’s investment in emerging markets should also pay off long-term, despite high-profile stumbles in China.
CEO Pascal Soriot has focused AstraZeneca (LSE: AZN) totally on R&D-led pharma. The company became a biotech play with a dividend attached. Then along came Pfizer’s bid and the share price rocketed. Astra has made significant progress in both its pipeline and its P&L, but the shares have been kept at lofty heights by management’s big promises. My fear is that any disappointment would see the stock punished along with management.
Dividends
Shell has been paying an ever-increasing dividend since 1945, so the 50% drop in oil prices over the past eight months is just a blip in its history. CEO Ben van Beurden has been cutting costs and capital expenditure, a process that could be accelerated if necessary to maintain the cash flow and payout. The US administration is poised to allow Shell to resume drilling in the Alaskan Arctic, which should augur well for its future reserves.
Meanwhile BP (LSE: BP) is still counting the cost of its oil spill in the Gulf of Mexico. The uncertainty of just how many billions of dollars in fines and compensation it will ultimately pay hangs over the company’s valuation. BP is also extraordinarily exposed to Russia: its 20% share in state-owned Rosneft accounts for over half its proven reserves of oil and nearly a quarter of its gas. That’s a double-whammy of risk. BP has a track record of being done over (Sidanko) and having close scrapes (TNK-BP) in Russia. Western sanctions now place the company between a rock and a hard place.
