Health Sector Horrors

This story features SONIC HEALTHCARE LIMITED, and other companies. For more info SHARE ANALYSIS: SHL

The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

People are always going to get sick, right? And thus need doctors, tests, hospital beds and drugs. That's what makes the healthcare sector of any region's stock index a “defensive” one, Along with consumer staples (we have to eat) and utilities (we need electricity, gas and telecoms), healthcare forms a triumvirate of life's necessities, within which are stocks investors seek in times of market turmoil given relatively stable income streams.

The problem is however, that life's necessities are also important to government fiscal policy. Thus defensive stocks, particularly health and utilities, are subject to subsidy regimes and price-setting. This is where capitalism and socialism clash, and the defensive investor has to be wary of changes which are out of a listed company's control. This is particularly the case when the government is running a deficit and looking for budget cuts.

Pharmaceutical retailing is one such area that comes in for heavy government interference, given the premiums global drug companies expect for their new, potentially life-saving products. Capitalism allows those companies to enjoy a window of revenue exclusivity given it was they who spent all the money and effort, while socialism ensures this window eventually closes and generic replications are sanctioned, and that part of the excess cost of new drugs is borne by government subsidy in the meantime.

A listed pharamceutical company is thus at the whim of government policy before it even begins to deal with market competition. Constant changes to Australia's Pharamceutical Benefits Scheme (PBS) has ensured a rocky ride for many years for a struggling Sigma Pharamceuticals ((SPI)), but it was also a case of competition, low margins, high debt levels and goodwill write-downs which led to Sigma's 17% profit downgrade at its interim result in early April.

After returning from a trading halt, Sigma shares lost around half their value, and things did not improve when top executives started heading for the exit. Stock analysts were split, with half believing the price plunge meant Sigma was offering value while others stuck with Sell for a company which may have been in its deathroes, needing to sell assets just to cover debt.

But now that an African pharma company has made a takeover bid at an effective 70% premium, there is investor relief all round. The Board has nevertheless rejected the offer, and analysts note that despite the premium the 60c offer price is still well short of the 90c odd the stock was trading at before its downgrade. All of Macquarie, UBS and GSJB Were upgraded their Sell ratings to Hold ratings this morning, while Credit Suisse remained on Sell pending confirmation.

In the meantime, hospital and pathology lab operator Healthscope ((HSP)) has also received a takeover offer, this time from a US private equity firm. The increased bid of $5.75 is seen by analysts as pretty reasonable given a lack of any short term earnings catalysts, albeit it still only represents a break-up valuation.

So Sigma and Healthscope investors have been “rescued” perhaps, but they will not be ahead on longer term investments in these companies despite takeover premiums.

Will white knights (or even black ones) also turn up for pathology and radiology provider Sonic Healthcare ((SHL))? Sonic was beating a familiar drum on Friday when a 12% profit guidance downgrade saw its shares drop around 30%. The run of downgrades only shows that both company executives and stock analysts had underestimated the current sad state of the Australia's competitive commercial healthcare sector. And further potential regulatory pain for subsidies still hangs as a cloud.

Is is regulatory uncertainty which has this morning driven Deutsche Bank's analysts to capitulate and downgrade Sonic straight from Buy to Sell. Deutsche can see pathology volumes recovering in the future, but not for a while.

Citi, on the other hand, is backing that recovery, albeit with fingers crossed. Citi this morning took the big drop in Sonic's share price as sufficient reason to upgrade to Buy.

And then to complete the woes in the pathology club, Primary Health Care ((PRY)) has also downgraded its profit guidance by 9%, citing the changes to subsidies in November a the major cause of lost revenues. This time analysts saw it coming, given Sonic's earlier shock.

Defensive?

Investors expect cyclical stocks to be the volatile ones, and defensives to be the place to run and hide in times of trouble. But a combination of strong competition in a privatised medical market and the whim of government policy has meant the healthcare sector has offered only significant volatility as well.

It is a lesson surely learned earlier by long-suffering Telstra ((TLS)) shareholders. When government policy is paramount to share price value, it is hard to call any stock reliant on such policy as “defensive”.

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