Rudi’s View: Healthcare Under The Scanner

Rudi's View | Mar 13 2024

In this week's Weekly Insights:

-Healthcare Under The Scanner
-February 2024; The Final Verdict
-Rudi Unplugged, In April

By Rudi Filapek-Vandyck, Editor

Healthcare Under The Scanner

Technology companies and discretionary retailers might have crowned themselves as Champions during the local reporting season in February, post-season the focus among analysts goes mostly out to Healthcare and REITs, two market segments that have largely been on the nose ever since the world decided covid is just something you deal with.

The irony that healthcare services are among the most persistent victims of what became an enormous global health scare back in 2020, now in the fourth year post pandemic, shouldn't go unnoticed. Reality does have a way of carving out its own pathway, ignoring forecasts made and solidly beating human imagination.

Double irony: healthcare had been by far the best performing segment on the ASX pre-covid, with local sector leaders CSL ((CSL)), ResMed ((RMD)), Cochlear ((COH)) and Sonic Healthcare ((SHL)) delivering above-average returns for long-term oriented portfolios.

In their slipstream followed a queue of smaller-cap performers, including Ebos Group ((EBO)), Fisher & Paykel Healthcare ((FPH)), Nanosonics ((NAN)), and others.

In 2024, it's much more slim pickings to identify outperformers in the sector, or even 'performers' if we exclude brief, short-term share price moves. Pro Medicus ((PME)) and the aforementioned Cochlear have turned into stand-out exceptions, but their ongoing attraction has now become a public debate revolving around 'valuation' and 'true sustainable growth perspectives' for the years ahead.

In a market that likes to reward companies for reliable, oversized growth with no negative surprises, and both healthcare outperformers are certainly part of that group of companies locally, there will always be that investor dilemma of how much premium is too much?

The more interesting question for most investors relates to the rest of the sector: when can we expect the return of healthcare as a solid, reliable provider of strong growth, with no material negative surprises? Call it the good old days, when ResMed, believe it or not, was one of the best performers on Wall Street with a total return in excess of 1000% over ten years.

There's no denying, the operational context for many healthcare companies has changed. There's also no denying share prices for the past three years are reflecting exactly that.

Bugbears include the advent of competing treatments and medications, such as GLP-1s, the modern day miracle weight loss solution (for now), but equally so budget constraints for governments, for hospitals, and for households, fewer GP visits, and a marked pick-up in general costs.

Margin pressure has become the new focal point for the industry at large. Most analysts, and management teams at the helm of these companies, remain confident today's margins will improve in the years ahead, but maybe not to the levels witnessed pre-covid.

This will have consequences for general valuations, and for investors' enthusiasm to invest in the sector.

History shows, what usually happens when a sector remains under the pump for a longer-than-expected period, there usually follows a number of wash-out events, whereby the weakest, lower-quality and most vulnerable business models implode as the relentless pressure builds.

Recent events at Healius ((HLS)), which have driven the share price to its lowest level in more than 23 years, is such an outcome. Once again, also, investors have been reminded of the dangers of owning cheap-looking sector laggards for no other reason than the 'price'.

So let's assume we have cash to spare, and we are hopeful the current spell over the healthcare sector will not prove permanent. Where should we be looking to invest?

I asked the analysts.

The local market leader, CSL ((CSL)), has for many years carried the halo of 'probably the highest quality growth stock on the ASX' but general appraisal has gone silent as the share price keeps reverting back to the $280 price level in line with disappointing margin recovery to date and more negative market updates.

Spending more than US$1bn on developing and trialling CSL112 and ending up empty-handed is not something witnessed every day either locally or elsewhere.

The acquisition of Swiss company Vifor, costing circa US$11.7bn, has not been a grand success either, at least not in the initial phase of ownership. Vifor is being challenged in some of its key products.

Losing the label of apparent immortality has made the local analyst community noticeably less enthusiastic too. Model portfolios have scaled back their allocations, albeit generally in small gestures. Some analysts, like those at Wilsons, have now turned super-critical of the business, labelling Vifor a 'dud' and questioning CSL's small base for future growth.

The majority, however, focuses on the 80% of CSL that is performing well, with ongoing prospects for robust growth and recovering margins; plasma collection and vaccines.