Rudi’s View: Re-Opening Opportunities In Healthcare

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In this week's Weekly Insights:

-Re-Opening Opportunities In Healthcare
-Conviction Calls
-Research To Download
-FNArena Talks
-AIA Investor Day In Sydney

By Rudi Filapek-Vandyck, Editor FNArena

Re-Opening Opportunities In Healthcare

US midterms, crypto failures, China re-opening and US CPI have pushed corporate profits into the background recently, but investors would be wise to not let their attention weaken.

Some important signals are there for everyone to see, both locally and internationally.

In the US, the Q3 reporting season, virtually finished, is accumulating into the weakest since Q3 2020; two years ago. The problem, thus far, is not so much with sales and revenues, but with a peak in profit margins.

Aggregate top line growth is still recording 10% growth year-on-year but at the bottom line growth has fallen to no more than 2%. And the outlook, it appears, remains sombre with forecasts for the quarters ahead worse or at best of similar magnitude.

Many forecasters worry the US economy might be in recession by early next year and corporate profits will increasingly start to reflect this downturn challenge.

Wilsons, on Monday, made the following prediction:

"A US downturn (even if it does prove to be a recessionary downturn) is likely to be mild by historical standards, but would likely still send the US earnings cycle into contraction mode."

Locally, the majority of market updates have failed to trigger a positive share price response and quite a number of recent updates has seen share prices weaken noticeably, including for Xero ((XRO)), News Corp ((NWS)), Sims ((SGM)) and James Hardie ((JHX)) –  and Elders ((ELD)) on Monday.

Admittedly, the sharp Buy-everything short-covering rally that has ensued post the US CPI release last week has seen these share prices in strong recovery mode since, but that would be to ignore the underlying message that corporate Australia, yet again, is polarising around profit growth momentum.

Within this context, Friday's Q1 trading update by private hospital operator Ramsay Health Care ((RHC)) might well prove important on multiple levels:

1. As far as Ramsay's Australian business is concerned, the re-opening momentum is strong and positive

2. The business continues to struggle with multiple headwinds in Europe

Those who've been following Ramsay Health Care know the business has been struggling to keep operational momentum positive since 2016 when, not by coincidence, the share price peaked well above $80.

And while many an expert/stock picker has nominated the shares for a post-covid opportunity, it has been a two steps forward, one step backwards, difficult trajectory for the company over the past two years.

Analysts are quite divided about Ramsay's future return profile: should one emphasise the positives locally or worry about the ongoing headwinds internationally?

Ramsay's market update also yet again highlighted sections of the healthcare sector on the ASX are now beneficiaries of the re-opening of societies – a fact the share market seems to have all but forgotten about when short-term momentum is all about banks, financials, cyclicals and commodities.

If those worries about international recessions next year return front of investor minds, it is likely All-Weather Performers in the healthcare sector will quickly return on investor radars – in particular those that enjoy re-opening benefits and recession-proof characteristics.

A brief run through the key constituents of the ASX-listed healthcare sector.

CSL

Plasma and vaccines company CSL ((CSL)) is the Grand Dame of Australian biotech and healthcare, or, if we want to choose a masculine label, the Emperor among Kings.

The share price hasn't progressed for its third year in succession (net), and on that basis, it would be easy to conclude the best years are now in the past, a la Ramsay Health Care. After all, doesn't the share market always know best?

Such assessment ignores the fact the global recovery in plasma collection is solidifying and CSL's R&D pipeline looks poised for a number of positive developments, on top of the recently acquired Vifor.

CSL is without the slightest doubt one of the highest quality operators on the local exchange. Forecasts are for double-digit percentage growth (ex FX) in successive years and the company's track record provides ongoing strong support for guidance provided by management.

Most importantly: history shows this company can achieve guidance and growth irrespective of economic slowdowns on the horizon. FNArena's consensus target is currently $324.80, more than 13% above the share price on Monday.

ResMed

Not dissimilar from the local healthcare Emperor, global sleep apnoea market leader ResMed's ((RMD)) share price is around the same level as in early January – a feat that should not be underestimated for what are, all else remaining equal, high quality growth companies trading on premium PE multiples.

ResMed is expected to reap long-term, sustainable benefits from product problems at competitor Philips. The recent quarterly update revealed momentum in regions such as Europe is not as strong, but the company remains on course for double-digit percentage growth for multiple years to come.

Chip shortages and other supply chain related headwinds are still preventing the company from maximising its growth potential in the short term, but underlying increased market share and margins are preparing for the next future upside surprise.

A visionary ResMed is building a software-as-a-service (SaaS) addition to its medical equipment platform, but time is needed for decisive profit contributions.

Similar to CSL, society re-openings have created strong underlying demand for ResMed's products and services following covid interruptions in the prior two years.

Pro Medicus

Without any doubt, the most exciting success story in Australian healthcare in recent years has been delivered by imaging software company Pro Medicus ((PME)) whose ability to add ever more new customers, predominantly among US hospitals, at an increasing profit margin has defied all sceptics and surprised the many happy fans and well-wishers.

Similar to CSL and ResMed, Pro Medicus is developing global leadership built on technological advantages. The key difference: the global market Pro Medicus is targeting is still in its infancy. Customers, sales, profits, dividends and margins are all on a steep upward trajectory – and they have been for many years now.

Given it takes time to bring new customers on board with the company's leading software solution, forward estimates are relatively predictable, similar to CSL.

For all these reasons, Pro Medicus shares are trading on what looks at face value an eye-watering PE multiple of 113x FY23 consensus EPS forecast, but today's share price is not far off from where it started on January 1st.

Pro Medicus shares will never trade on market-conforming PE multiples, unless its growth story runs into troubles, temporary or otherwise.

Investors will simply have to get comfortable with management's strategy and execution, and grab the opportunity of a weaker share price at a level they feel comfortable with.

Not All Of Healthcare Is A Winner

Now that we highlighted three positive stories, it should be emphasised not every company carrying the healthcare label stands to benefit from re-opening momentum; some companies are looking forward to a much more challenging outlook.

Such challenges are likely to translate into a moribund share price trajectory ahead, with potential downward bias in case of disappointment.

Three major beneficiaries of covid testing are facing much tougher times ahead, even with other sections of their respective businesses now also enjoying recovery momentum; Sonic Healthcare ((SHL)), Healius ((HLS)) and Australian Clinical Labs ((ACL)).

While respective share prices might look "cheap" or "undervalued", this must be weighed up against the prospect of possibly declining EPS profiles, potentially beyond FY23.

Others, such as Fisher & Paykel Healthcare ((FPH)), might prove a big bargain at present share price level, but the market will want to see operational momentum turn for the better.

Similar questions surround the outlook for Cochlear ((COH)), Integral Diagnostics ((IDX)), Nanosonics ((NAN)), as well as Ansell ((ANN)).

The latter company is only "healthcare" by half (50%) but similar issues plague the outlook varying from being a previous covid-beneficiary, to currencies, cost inputs, and the prospect of economic recessions elsewhere in the world.

Ebos Group

One company that has been steadily growing its foot print in Australia is Ebos Group ((EBO)), of New Zealand origin.

Ebos celebrates its centenary existence in 2022, alongside its status of being the largest marketer, wholesaler and distributor of healthcare, medical and pharmaceutical products in Australia. The company has now added animal care brands to its business.

Among local retail outlets, investors might be familiar with the Terry White Chemmart or the Pharmacy Choice brands, as well as the Red Seal and Faulding consumer products. The company also runs Community Pharmacies.

Recent market updates, including at the company's AGM, further re-enforced operational momentum remains strong.

Longer-term, the impact from a resurrection in now Wesfarmers-owned Australian Pharmaceutical Industries remains an open question mark, but the company's track record to date, including acquisitions and their successful integration, is impeccable.

More Potential, More Risk

As with every other sector, there are always opportunities among riskier, small-cap, less developed businesses for investors who want more excitement and the potential for higher, outsized returns.

Companies that currently offer such potential, supported by positive bias from sector analysts include:

-Aroa Biosurgery ((ARX))
-Immutep ((IMM))
-Mach7 Technologies ((M7T))
-Telix Pharmaceuticals ((TLX))

Two healthcare-related names that often appear on analysts' lists of favourites are staff services provider PeopleIN ((PPE)), whose placement services include nurses and healthcare workers, and HealthCo Healthcare & Wellness REIT ((HCW)), whose assets are concentrated around hospitals; aged care; childcare; life sciences & research; and primary care & wellness property assets, as well as other healthcare and wellness property adjacencies.

Conviction Calls

Morgan Stanley has started to communicate its predictions for next year:

"For markets, [2023] presents a very different backdrop. 2022 was marked by resilient growth, high inflation, and hawkish policy. 2023 sees weaker growth, disinflation, and rate hikes end/reverse, all with very different starting valuations.

"It seems reasonable to think that we’ll see different outcomes, especially in high grade bonds. We forecast US 10-year Treasury yields to end 2023 lower, the US dollar to decline, and the S&P 500 to tread water (with material swings along the way)."

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Tactical and various other models at Longview Economics are yet again suggesting the rally in global equities is exhausting itself this month.

"While there’s a strong chance of a change in the (primary) trend in gold, rates and bond yields, that is less likely in equities. […]

"… the current bear market rally is likely nearing its conclusion."

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A general sector update on Australia's technology stocks has opened up a rather noticeable divide between JP Morgan and local retail partner Ord Minnett.

Ord Minnett white labels JP Morgan's research, with added opinion and views from a select group of its own in-house analysts, which seldom shows wide divergences from Big Brother's research.

But a five-step tiered rating system, versus only three for JP Morgan, plus some differences in views, quickly creates different dynamics between the two research partners.

The most obvious observation consists of less Buy ratings from Ord Minnett (as many less-positive Accumulate ratings cover JP Morgan's Overweights).

This leads to a smaller section of Buy ratings for Bravura Solutions ((BVS)), Data#3 ((DTL)), Hub24 ((HUB)), NextDC ((NXT)) and Superloop ((SLC)).

Key differences are JP Morgan only rating Hub24 Neutral, while also having Overweight ratings for Altium ((ALU)), Iress ((IRE)), WiseTech Global ((WTC)) and Xero ((XRO)).

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In local retail, Citi continues to have a preference (and Buy rating) for Coles Group ((COL)), Woolworths Group ((WOW)), JB Hi-Fi ((JBH)) and Super Retail ((SUL)).

For exposure to housing market leverage, Citi analysts prefer Harvey Norman ((HVN)) and Nick Scali ((NCK)). In fashion (in the broadest sense possible) current favourites are Lovisa Holdings ((LOV)) and Michael Hill International ((MHJ)).

The preference among retail REITs sides with Scentre Group ((SCP)) and Charter Hall Retail REIT ((CQR)).

Colleagues at Jarden stick with youthful consumers that can continue to spend, hence Universal Store Holdings ((UNI)), Accent Group and Premier Investments ((PMV)) are high on the list of favourites, alongside Treasury Wine Estates ((TWE)), The Reject Shop ((TRS)), Domino's Pizza ((DMP)), Woolworths Group, Costa Group ((CGC)), Wesfarmers ((WES)) and Flight Centre ((FLT)).

Jarden remains not keen on JB Hi-Fi, Endeavour Holdings ((EDV)), Nick Scali and Kogan ((KGN)).

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With private equity suitors commanding headlines in local media on a weekly basis, analysts at UBS have dug deeper into the local share market to assess which companies could be high on suitor's lists for a leveraged buy-out.

UBS' conclusion is funds management and retailers stand out as most attractive. This should not surprise given both sectors have been severely de-rated in 2022.

Yet GrainCorp ((GNC)) and Vulcan Steel ((VSL)) seem to rank the highest in the research, beating many other attractive looking candidates (sitting ducks?) including Super Retail, Adairs ((ADH)) and Accent Group ((AX1)), as well as Magellan Financial Group ((MFG)), Platinum Asset Management ((PTM)) and GQG partners ((GQG)).

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Credit Suisse's Model Portfolio guardians have highlighted three high-conviction calls from the broker's small-cap research team; Webjet ((WEB)), GUD Holdings ((GUD)) and McMillan Shakespeare ((MMS)).

Credit Suisse's all-cap Model Portfolio recently switched out of Harvey Norman into Brambles ((BXB)) to become more defensive and reduce exposure to consumer discretionary.

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On Thursday, FNArena reported how Morgan Stanley was making the case for adding gold exposure to portfolios.

Morgan Stanley liked Evolution Mining ((EVN)) and Newcrest Mining ((NCM)) the most, but downgraded Northern Star ((NST)) to Equal-weight and kept Regis Resources ((RRL)) on Underweight.

Colleagues at UBS had similar ideas, with their list of favourites consisting of Northern Star, SSR Mining ((SSR)), Evolution Mining, Gold Road Resources ((GOR)) and De Grey Mining ((DEG)) with both Newcrest Mining and Regis Resources rated Neutral.

Analysts at Macquarie, however, have a differing view. They believe as inflation will start trending down, and this creates an automatic headwind for gold and gold producers. Macquarie is thus of the view last week's sector rally offers an opportunity to sell into.

Macquarie's Top Picks for the sector are Norther Star, Gold Road Resources and, among smaller-cap names, Bellevue Gold ((BGL)) and De Grey Mining.

Research To Download

Research as a Service (RaaS) on:

-Betmakers Technology Group ((BET)) https://www.fnarena.com/index.php/download-article/?n=7C863347-92CD-4F44-D5AA3FA70E6BE0A8

-Metarock ((MYE)) https://www.fnarena.com/index.php/download-article/?n=7C981AEC-ECB2-13F0-C6EB98205E7F15B9

-Pointerra ((3DP)) https://www.fnarena.com/index.php/download-article/?n=7C9C2836-943D-1B67-BAD0F1CAA5B4AEF4

-Spenda ((SPX)) https://www.fnarena.com/index.php/download-article/?n=7CA3606B-94E3-9E60-F729A1697CE92A53

FNArena Talks

My latest interview by Peter Switzer includes a funny editing oversight (or two) but I'm on after circa 15 minutes, talking equity markets, inflation, interest rates, central banks and corporate profits.

Among those names receiving a mention are the Vanguard Australian Property Securities Index ETF ((VAP)), gold, Xero ((XRO)), Amcor ((AMC)), CSL, ResMed, Audinate Group ((AD8)), IDP Education ((IEL)), and WiseTech Global.

Total duration is circa 30 minutes: https://www.youtube.com/watch?v=mJ-HIHCKxUg

AIA Investor Day In Sydney

I won't be presenting this time around, but I might make a surprise attendance at the Australian Investors Association's (AIA) Investor Day in Sydney later this month.

Those interested in attending, use coupon RUDIpromo for a super early-bird ticket price of $59 only – includes lunch, morning and afternoon tea and networking drinks at the end of the day.

Sydney, on November 25:

https://www.eventbrite.com.au/e/aia-investor-day-2022-sydney-tickets-438541508457

(This story was written on Monday, 7 November, 2022. It was published on the day in the form of an email to paying subscribers, and again on Thursday as a story on the website).

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: info@fnarena.com or via the direct messaging system on the website).

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BONUS PUBLICATIONS FOR FNARENA SUBSCRIBERS

Paid subscribers to FNArena (6 and 12 mnths) receive several bonus publications, at no extra cost, including:

– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
– Make Risk Your Friend. Finding All-Weather Performers, January 2013 (The rationale behind investing in stocks that perform irrespective of the overall investment climate)
– Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
– Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow.
– Who's Afraid Of The Big Bad Bear? eBook and Book (print) available through Amazon and other channels. Your chance to relive 2016, and become a wiser investor along the way.

Subscriptions cost $480 (incl GST) for twelve months or $265 for six and can be purchased here (a subscription to FNArena might be tax deductible):

https://www.fnarena.com/index.php/sign-up/

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