Can Healthcare Stocks Continue their 2018 Rally?

Investors looking for defensive investments in an uncertain world may benefit from looking at healthcare stocks, which was the best-performing sector in 2018

David Brenchley 30 January, 2019 | 8:07AM

Drugs, tablets, pharmaceuticals, healthcare, defensive investments

In an uncertain environment for both risk assets and economies, it may be prudent for investors to look towards more defensive investments.

Clearly, there are a number of non-equity-heavy asset classes that can do the job – infrastructure being one, gold another. But for those keen to stay risk-on and in equities, healthcare also has defensive qualities.

Healthcare was one of only two equity sectors to record a positive return in the fourth quarter of 2018. The MSCI World Health Care Index was up 0.98% compared to the wider index’s 9.1% loss. In fact, it was the best-performing sector through 2018, ending the year up 2.51% versus the MSCI World’s 8.71% decline.

Healthcare companies tend to display some attractive qualities, like steadily rising cash flows, strong intellectual property within their drugs pipelines and dividend growth.

As well as these well-ingrained qualities, there are some clear long-term drivers for the sector moving forwards, according to Monique Wong, multi-asset portfolio manager at Coutts. The portfolios Wong works on have moved into healthcare since the 2016 US elections.

Demographics Prove a Tailwind

First, most big countries in the developed world have an ageing population, which means healthcare products will be in demand. Second, the growing affluence of emerging market consumers will see demand there for higher-quality healthcare ramp up.

There’s innovation in the space, too, in both drug pipelines but also technologies being used. Wong points to areas like medtech – robotic surgery and 3D printing in particular.

These are also areas David Older, head of equities at Paris-based asset manager Carmignac, is excited about, too. His Carmignac Patrimoine fund invests in Intuitive Surgical (ISRG), which is the leader in the robotic surgery field. Its da Vinci platform allows doctors to perform very precise operations remotely with just minor incisions.

“There’s much lower risk of infection and doctor error and recovery rates are much quicker,” Older explains. “The whole volume aspect is very attractive – patients love it and hospitals love it.”

The fund also owns Stryker (SYK), which is the number two and three player globally respectively in knee and hip replacement surgery.

For Ben Peters and Chris Elliott, co-managers of the Evenlode Global Income fund, healthcare is a key area and the fund has around a fifth of its concentrated portfolio invested there. “As long as the global economy keeps on expanding, people will increasingly want their health looked after,” says Peters.

“There’s lots of intellectual property in the patented drug portfolio of a pharmaceutical company. Now, they do need to invest to keep replenishing that portfolio, but providing you have a good, science-driven research & development department it should be able to deliver value through the cycle.”

While they invest in drugs companies, they also like healthcare services companies. One of the most recent additions to the portfolio was Quest Diagnostics (DGX), which provides pathology and laboratory services to hospitals and healthcare professionals throughout the US.

The share price has been under pressure due to the passing of the Protecting Access to Medicare Act (PAMA) through US Congress. The act aims to reduce the cost of providing tests to Medicare-funded patients, which account for 12% of Quest’s revenues.

But, instead of being a headwind for the company, Elliott believes it will be a positive. While it will mean the larger players like Quest will take a cut in their pricing, it will really hit the smaller players like in-hospital and community labs. As a result, they will be looking to be swallowed up by the big players at what are likely to be attractive valuations.

Of course, it may well be that regulators decide this scale of consolidation is not positive for the industry, in which case they would likely row back on PAMA. “Either way that plays out quite nicely for Quest.”

On the fundamentals, the firm has shown very steady cashflow generation for a long time, says Peters, and the team expects that to continue. There’s a good pathway to growth, too, from expanding its services to both new and existing customers.

Healthy M&A Activity 

M&A activity has also been at the fore of the sector through 2018. Japanese firm Takeda (4502) bought Ireland’s UK-listed Shire for $46 billion, while Eli Lilly (LLY) and Bristol Myers (BMY) have announced they will be buying Loxo Oncology (LOXO) and Celgene (CELG) respectively.

Wong says Coutts’ portfolios have benefited from these deals due to having exposure to the target companies. Their choice of fund manager, Polar Capital Healthcare, owned both Loxo and Celgene, while they had a direct stock holding in Shire.

Of course, there is the risk of regulation dampening the story somewhat. Indeed, it’s one of the only areas US President Donald Trump and the Democrats agree on. With the turn of the House of Representatives from Republican to Democrat control, Older worries about this with regard to the pharma companies.

“Trump has been very vocal about wanting to get pharmaceutical prices down. So that could be an area we see Trump and the Democrats trying to work together – it seems like an easy win could be there.”

Ailsa Craig, investment manager at SV Health Investors, accepts these political risks. In order to mitigate the risks, International Biotechnology Trust (IBT) has been focusing on areas that have pricing power.

For example, 40% of the portfolio is in oncology names including top holding Incyte (INCY). “We don’t feel like that is an area that will be targeted for price controls,” says Craig. Rare disease is another area of interest as it’s been ring-fenced in the US to motivate companies to innovate and treat these diseases.

Areas the trust is moving away from are infectious disease, which has become almost completely commoditised, and mega caps like Amgen (AMGN), which have seen their fundamentals deteriorate. “Their growth rates have shrunk, primarily because they’ve become so successful and really large,” says Craig.

Now, they are looking at the companies in the developmental stage – “where we think the next generation of mega-caps will come from”.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Amgen Inc204.02 USD2.36
Bristol-Myers Squibb Company46.98 USD2.69
Carmignac Pf Patrimoine F GBP Acc120.80 GBP-1.16
Celgene Corp94.70 USD1.49
Eli Lilly and Co110.52 USD0.26
International Biotechnology Ord636.00 GBX0.32
Intuitive Surgical Inc495.45 USD-0.88
Polar Capital Healthcare Opports Inc31.73 USD-0.44
Quest Diagnostics Inc100.60 USD0.71
Stryker Corp217.00 USD0.79
Takeda Pharmaceutical Co Ltd3,540.00 JPY-2.07
TB Evenlode Global Income B GBP Acc1.26 GBP0.10

About Author

David Brenchley

David Brenchley  is a Reporter for Morningstar.co.uk

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