Firm News

Healthcare: Equity Preferences

We believe the health care sector offers attractive long-term growth and in the aggregate trades at a substantial valuation discount to the broader equity market.

The life sciences tools and services industry has strong secular growth drivers and will likely benefit from continued government and industry spending on medical research. (ddp)

In the near term, however, perceived risks to US health care policy could limit health care sector performance, and thus the sector outperformance will likely occur once there is greater clarity on health policy. That being said, downside risk for the sector appears limited, and the sector should offer good protection if markets experience a bout of volatility.

On balance, we view the pharmaceutical and biotechnology industries as Neutral. While we believe the pharmaceutical and biotechnology industries have significant potential for outperformance over the next 12 months, we think near-term upside is limited because of health policy uncertainty, specifically around US drug pricing. We also note that pharmaceutical and biotech valuations are at historically low levels, which we think have the potential to correct upward if drug pricing uncertainty is reduced during 2021.

Health care equipment and supplies are relatively well positioned from a health policy perspective and benefit from consistently growing and durable underlying end markets. Longer term, health care equipment and supply companies should retain their attractive growth profiles and thus their premium valuations relative to the broader market. We view health care equipment and supplies as Most Preferred.

The life sciences tools and services (LST) industry has strong secular growth drivers and will likely benefit from continued government and industry spending on medical research. LST companies are well insulated from the health policy issues currently being debated in Washington, and medical research funding is widely supported by both major US political parties. We view the LST industry as Most Preferred.

Within the health care providers and services market, we focus mainly on the managed care companies (MCOs) that provide health insurance to employers, governments and individuals. The long-term growth outlook for MCOs is favorable, in our view, and valuations relative to the S&P 500 remain quite attractive. That very appealing backdrop is tempered near term, however, by some lingering policy uncertainty heading into the next Administration and Congress. We view the health care providers & services industry as Neutral.

Key investment themes within health care

We see multiple long-term investment themes within health care.

  • Innovation: not surprisingly, companies with new products and services that either meet previously unmet needs, or provide better solutions to existing health care conditions will attract capital and benefit from strong growth;

  • Efficient rationing: because health care spending typically grows faster than payers’ incomes (government budgets, employer revenue, individual incomes), companies that can help payers efficiently ration their health spending should see increasing demand for their services;

  • Scarcity of visible/enduring growth among larger diversified companies: despite health care’s strong underlying growth dynamics, there is a scarcity of consistent long-term revenue growth within the health care sector for the largest companies. Large companies that can offer consistent, visible long-term revenue growth are well-positioned.

  • Consolidation: large incumbent companies with entrenched sale forces and deep customer relationships will continue to fuel their growth by acquiring smaller companies with innovative products.

  • Gradually expanding government role in health care: this is principally a US dynamic, as most other developed nations have government funded health care systems. Over the last 55 years, the government's role in the health care system has gradually expanded, particularly as a payer. According to the Tax Policy Center, the US federal government spent nearly USD 1.2tn in 2019, or approximately 32% of total domestic spending, on health care. This trend will likely continue through eventual expansion of current government health insurance programs: Medicare, Medicaid, and the Affordable Care Act (ACA/ObamaCare) health exchanges. Importantly, MCOs all participate in those programs and many serve as critical service providers that enable these government programs to function. This relationship should continue as government’s role as a payer continues to gradually increase.

Reach out to your East Pacific Bank financial advisor for a copy of the latest report on Healthcare and our equity preferences.