An 8% fall in healthcare stocks in October is creating opportunities in the sector. But value remains elusive and a global perspective to healthcare investing is needed.
The S&P/ASX Health Care Index has fallen 15% since its peak in August 2016, underperforming the broader share market. Poor company results and renewed fears about a Donald Trump presidency in the United States this week crunched the sector.
A Trump victory, considered a lower probability a few weeks ago, leapt onto the market’s radar this week after further revelations in the Hillary Clinton email affair. As I wrote for the Switzer Super Report in early October [1], a Trump presidency could not be discounted.
A Trump presidency, still less likely than a Clinton one, would be a poor outcome for the US healthcare sector. Healthcare is a key political divide between the Democrats and Republicans: Clinton wants to strengthen the so-called “Obamacare”, while Trump wants to repeal it and replace it with another system.
Australian companies, such as Sonic Healthcare (SHL), which earns more than a fifth of its revenue in the US, would suffer. CSL (CSL) would be among the few winners if a Trump government created free-market drug pricing – a big if, given the power of the US pharmaceuticals lobby.
The narrowing of Clinton’s lead in the opinion polls could drive Australian healthcare stocks lower in the lead-up to the November 8 US election, creating a buying opportunity. Keep an eye out for irrational selling if markets position for another Brexit-style event.
Chart 1: ASX 200 Health Care
Source: Yahoo Finance
Company news has also weighed on the sector. A disappointing round of Annual General Meetings (AGMs) for Australian healthcare companies in October reinforced the challenges – slowing volume growth in some key services, pricing pressures and regulatory risks.
ResMed Inc (RMD) reported a disappointing FY17 first quarter because of flat mask sales in the Americas. Slightly higher-than-expected costs guidance is a concern, but ResMed is starting to offer better value.
Estia Health (EHE) continued its run of bad news, reducing underlying profit guidance. Weaker-than-expected growth in occupancy costs across its portfolio of aged-care facilities, and higher labour costs, are weighing on its outlook. Down 62% over one year (on a total-return basis), Estia still looks more like a value trap than good value, for now.
Emerging value in Healthscope (HSO)
Hospital and medical-centre provider Healthscope led the sector falls in October after announcing slower-than-expected revenue growth. Volumes in orthopaedic and ophthalmic surgery, slightly down on this time last year, have become headwinds.
Healthscope has fallen 30% from its 52-week high to $2.20. The stock is flashing up as a buy on consensus broker forecasts: eight of 12 broking firms rate it a strong buy, or buy, and the median target price is $2.65, according to Thomson/First Call.
I’m not quite as bullish. Healthscope management said negative publicity about prosthesis pricing was encouraging more patients to defer procedures. It said volumes in July were “soft”, August was marginally better and that September was “horrendous”. Growth in underlying operating profit (EBITDA) could be flat year-on-year if these trends persist.
The risk is that this trend is not just a cyclical blip as patients who deferred procedures in the first quarter of FY17, because of negative publicity or for seasonal reasons, have them in the second or third. The Federal Government clearly has its sights on healthcare costs and private healthcare insurance affordability through the Medicare Benefits Schedule Review and other measures.
Although the long-term fundamentals are strong for private-hospital operators, regulatory risks could conspire to curb the sector’s previous high growth.
Nevertheless, Healthscope deserves a spot on portfolio watchlists. Opportunities to buy high-quality healthcare companies – Healthscope is one of them – at or below fair value are rare.
At $2.20, it is trading on a forecast Price Earnings (PE) multiple of about 18 times for FY17, consensus analyst estimates show – reasonable for a company with a strong position in an industry with favourable long-term prospects.
The low end of broker consensus price targets for Healthscope – $2.40 – looks realistic. That suggests Healthscope is marginally undervalued at the current price. After being overvalued for most of this year, there is a window for cautious buying.
I’ll be watching Ramsay Health Care’s AGM on November 9 closely for more information on hospital industry conditions. If recent weakness in prosthesis procedures looks temporary, Healthscope’s price descent could stabilise. The stock has plenty of work ahead to restore market confidence after falling 70 cents in a day on its AGM news.
Chartists will look for Healthscope to hold price support around $2.15, the most recent price low in February 2016. If it significantly breaks that support, best to stand aside in the near term.
Source: Yahoo Finance
Ansell (ANN) looks a touch oversold
I included the maker of condoms and medical, industrial and household gloves in the Switzer Super Report in December 2015 at $19.96. Ansell rallied to a 52-week high of $24.90, before falling to $21.13 amid the broader selloff in healthcare stocks.
At its AGM in October, Ansell said its first-quarter results were on track and that it saw less downside risk to its FY17 results. It lifted its FY17 earnings guidance range to US$1-$1.12 – an improvement of 4-17%. Although demand for its product remains subdued, Ansell continues to target organic growth of 2-4% in FY17.
Wide earnings-per-share guidance of 4-17% reinforces the uncertainty in Ansell’s markets, but it was a solid update, relative to several other healthcare companies. Management is growing the business, albeit slowly, in tough market conditions, which is always a good sign.
Eight of nine broking firms have a hold on Ansell, four have a sell, and one has a buy. A median share-price target of $17.59 suggests the stock is materially overvalued.
Ansell has plenty of challenges, but not enough near-term problems to warrant a 6% fall in October, particularly after a small guidance upgrade, albeit against low market expectations. How many other healthcare companies are upgrading earnings?
The market had, justifiably, been concerned over uncertainty for Ansell’s FY17 earnings, something that should be partly mitigated by the company’s recent comments about its improving confidence in the outlook for this financial year.
Its Sexual Wellness (condom) division is performing solidly with 8% sales growth, and its medical-gloves division should improve as supply constraints for synthetic surgical gloves end in FY17. A potential divestment of the Wellness division could be a share-price re-rating catalyst as Ansell focuses on its business-to-business operations.
Ansell’s takeover prospects are another attraction, though not the main reason for buying.
Like Healthscope, Ansell looks moderately undervalued. Neither stock is a raging buy, but there is emerging value after recent share-price falls.
Source: Yahoo Finance
Go global with healthcare
Investors seeking healthcare exposure should not limit their search to Australia. There are only a small group of large healthcare stocks on the ASX, and the same is true of medical devices once one gets past Cochlear and ResMed.
The scarcity of large healthcare companies on the ASX arguably inflates their valuation compared with their closest offshore peers.
For example, the world’s largest medical-devices company, Medtronics, trades on a PE of 15.5 times for FY18 earnings, consensus analyst estimates show. ResMed, a smaller company with a far narrower product focus, trades on 19 times.
Ramsay Health Care, a terrific long-term performer, trades on a forecast 2016-17 PE multiple of 27 times, using consensus estimates. HCA Holdings Inc, the largest private-hospital owner in the US, trades on a forward PE of 11 times, and US hospital giant Universal Health Services trades on a forecast PE of 15 times.
Simply put, dominant healthcare companies in much larger markets are often cheaper than those based in Australia.
I favour the iShares Global Healthcare Exchange Traded Fund (ETF) for exposure to a basket of the world’s best healthcare companies. Bought and sold on ASX like a share, the ETF aims to replicate the price and yield performance of an index that includes Johnson & Johnson, Novartis AG, Pfizer Inc, Roche Holding Par AG, and Merck and Co Inc.
Two thirds of the index is based on US healthcare companies and it traded on an average trailing PE multiple of 20.8 in October 2016, iShares data shows – less than the PE of many large Australian healthcare stocks.
The iShares Global Healthcare ETF has an annualised return of 22% over five years to September 2016. It’s unhedged for currency movements, so returns will suffer if the Australian dollar’s gains against the Greenback and other currencies continue.
The ETF looks a good choice for long-term investors who want to add diversified global healthcare exposure to their portfolios and take advantage of lower valuations in this sector since August.
Source: Yahoo Finance
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. All prices and analysis at November 3, 2016.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.