Buy Hold Sell: Why healthcare still needs some reviving (and 2 strong buys in the sector)
While healthcare was clearly the lifeblood of the Aussie market over the last decade, the last two years have seen many of these long-term compounders barely register a pulse.
Sure, pathology players like Sonic Healthcare (ASX: SHL) and Healius (ASX: HLS) benefited from the COVID-19 crisis, but many other favourites slumped with elective surgeries on ice and stimulus payments injected into economies.
So what have the professionals taken away from the last two years of investing in this sector? And now the COVID-19 panic is calming down, could some of the harder-hit healthcare stocks come back to life?
In the second of our Buy Hold Sell sector specials, Livewire's James Marlay was joined by two stock surgeons - Alphinity's Stuart Welch and WILSONS' Melissa Benson - for their outlook on the sector, as well as the headwinds (and tailwinds) that are swelling as we speak.
Plus, they also analyse three healthcare favourites and each name a strong buy within this sector right now.
Note: This episode was filmed on Wednesday 28th September 2022. You can watch the video, listen to the podcast or read an edited transcript below. A note that Melissa works on the "sell" side and Stuart works on the "buy" side of markets.
James Marlay: Hello and welcome to Buy Hold Sell, brought to you by Livewire Markets. My name's James Marlay and today we're taking a sector deep dive into the healthcare part of the market, a really interesting space. And to help me get through this subject, I've got two healthcare specialists, Stu Welch from Alphinity. Stu, great to see you. And Melissa Benson from WILSONS, thanks for making a debut on Buy Hold Sell.
All right, an easy one to start off with, folks. It would be remiss of us not to touch on the fact that markets have been really volatile, a really bumpy ride. Stu, the million-dollar question. How do you make sense of it?
Stuart Welch: It's a tough environment. Central banks are doing their best to put the inflation genie back in the bottle. I think we saw a sharp rally in July as people thought the pivot wasn't far away. I think what we've seen is that increasingly tough rhetoric and basically at least what we do know is that we'll be starting from a higher interest rate point and that pivot is possibly further away than people had expected. So it's a challenging environment for equities.
James Marlay: The end in sight for interest rates really got pushed a bit further down the line. Melissa, have you got anything to add in terms of your read on the environment at the moment?
Melissa Benson: I mean, I think exactly what Stu said around healthcare, the volatility is a little bit impractical sometimes. Not really related to anything fundamental, but a lot of volatility in the sector.
Lessons from investing in healthcare during a pandemic
James Marlay: Okay. Well let's get into the sector where you are an absolute specialist, I had a bit of a gander, had a look back through your history, lots of studying in that area. The ASX 200 Healthcare Index has 14 companies, the big names CSL, Sonic, and ResMed. What's the lesson that you learnt from looking at that sector over the past few years?
Melissa Benson: I think one particular thing is that healthcare is very defensive in terms of the demand profile, but perhaps the investment risk profile for the sector is a lot more cyclical than we might have thought. And it is a lot more decoupled from that demand, I would say.
James Marlay: Okay. Stu, anything to add to that? What did you learn about investing in healthcare over the past few years, particularly with the pandemic in the background?
Stuart Welch: I think the key takeaway for me is that the healthcare sector here in Australia is just so varied. I mean each one of the stocks has had such a different ride during COVID that it's been remarkable in terms of how different each one of their stories has been. And I think to make any sector-wide conclusions from that is challenging because each one of them is so different. The key takeaway is that you need to understand each stock, its journey, and where it's come from over the last couple of years, to have any chance of trying to work out what the future holds for them.
Headwinds and tailwinds for the healthcare sector
James Marlay: Okay. This might make the next question a little redundant, but I'm going to put it to you anyway. Headwinds and tailwinds for the sector, any particular things that you would call out?
Stuart Welch: I think one thing I've definitely seen in healthcare, and I think is a global challenge, is access to labour and what you have to pay for that labour. I think it's particularly acute on the healthcare side. I've definitely seen a lot of healthcare practitioners, particularly nurses in hospitals and GPs in the community setting, just burned out post-COVID. And a lot of them have brought forward retirement. So there's a shortage of labour, which then amplifies the problem for those that are left behind. And so I think that's an issue in terms of whether or not you can actually service that workload. And then on top of that, whilst we've dialled back a lot of these COVID-related restrictions in the community, I mean cases are still live in the hospital and so the absenteeism, COVID related, is still a major issue for a lot of these people.
James Marlay: Melissa, headwinds, tailwinds that you're seeing in the sector?
Melissa Benson: For a headwind - I think if you zoom in, Australia has a lot of biotechs on the ASX. Obviously, we are in a risk-off environment, and these are companies that need capital markets to support their funding and development. So that's a big headwind for those guys. I think tailwinds, I see more on the technology adoption side of things. While healthcare traditionally is ahead of the curve in a lot of ways, the tech infrastructure in hospitals is well behind the curve. So COVID's really ramped that up and brought that forward. So businesses that have cloud or connected devices, I think that's a big tailwind for those guys.
Why Alphinity is underweight
James Marlay: Now, Stu, I understand at Alphinity you are underweight the sector at the moment, just a single holding in the healthcare space. What would it take you to change that positioning and get a bit more constructive?
Stuart Welch: We don't look at it as a sector positioning, like a top-down side of things. We look at it more on a stock-specific basis. So it's a bottom-up stock-specific story. We look for companies that are reasonably valued, high quality in terms of their earnings and then also in or entering an earnings upgrade cycle. And so for us, it's hard to say if there's any one thing that would dictate that would increase our sector weight in healthcare. It would much more be about stock-specific stories driving us in that we would end up in aggregate overweight, but certainly not a top-down target for us.
James Marlay: And so based on that, given you have one position, you're seeing the earnings environment for these companies a bit challenged at the moment?
Stuart Welch: Yes, I think that's right. I mean, if we look around in terms of the companies that have been getting earnings upgrades, there are very few in the healthcare space that are actually getting earnings upgrades. And I think that's part and parcel of some of those headwinds that I was talking about before. But a variety of different things. Each stock has a different story.
Ramsay Health Care (ASX: RHC)
James Marlay: Okay. Well, let's get into our stocks for the Buy Hold Sell episode, starting with Ramsay Health Care. Really interesting. KKR have walked away from a bid, stocks down to around $56, last time I had a check. Buy, hold or sell?
Melissa Benson (HOLD): I'd still say, despite that, it's a hold. I think Ramsay needs the three parts of their business to be working well to be a buy, in our view. And obviously, the UK and Europe are really suffering from, as Stu mentioned before, those staffing shortages are at all-time highs. And so even though the Australian business' CapEx growth outlook is quite strong, I think when you have the earnings growth being hampered in those other two parts of the business, it's still just a hold for us. So it's just time to sort that nursing shortage.
James Marlay: Okay, Stuart, buy, hold, or sell on Ramsay?
Stuart Welch (SELL): So we'd have it as a sell. I think at this point it's still getting earnings downgrades through some of those challenges that I was talking about before, in terms of access to labour and some of the disruptions to operations from absenteeism and the like. So we still see those earnings downgrades coming through. And despite it being quite attractive in terms of valuation at these levels, those earnings downgrades typically cap any valuation upside and you end up caught in a value trap. So for us, it's probably a sell. I mean I think the key upside here was obviously the KKR corporate activity, but given the recent news that they've ceased discussions, I think that that's off the table for now.
James Marlay: It seemed pretty final.
Stuart Welch: Yeah, it seemed pretty final.
ResMed (ASX: RMD)
James Marlay: Next up is ResMed. Now, a lot of things in the background that would seem constructive for that business, one of its major competitors having a big product recall. Buy, hold or a sell?
Stuart Welch (HOLD): So that's probably more of a hold. Certainly, its key story has been that its key competitor, Philips, has had a product recall and they've been out of the market as they try to remediate that problem and are unable to service new customers. And ResMed certainly had the opportunity to take market share during this time. I guess the key challenge they've had is access to computer chips to be able to produce the devices, particularly the coms chips. That seems to be improving now, but also at a time when Philips is getting towards the end, and whilst that recall may be extended, they'll probably be back in the market in the next six months at some point, in some capacity. So things are looking a bit more balanced there. And when you look at valuation relative to pre-COVID levels, if you take out the ultra-low interest rate period, it is still screening a little bit expensive. So for those reasons, I think it's probably more of a hold for us.
James Marlay: It rallied well into the result in August. Buy, hold or a sell?
Melissa Benson (BUY): I would say we are a buy, we are a little bit more positive than Stu on the outlook for when Philips is back in the market. And I think around those chip shortages, that is a frustration for ResMed, but I think their card to cloud device, is a really smart way to get around it, and still gain a bit of market share. We think that there should be good operational leverage that they'll build out over the next three years in the margin there, at a time when they're just taking more market share. We think they could consolidate to a Cochlear level of 70% global share and that just really gives them some good sales productivity leverage. So we're a buy.
Cochlear (ASX: COH)
James Marlay: Okay, well let's talk about Cochlear. It's actually outperformed the ASX200 on a 12-month basis, which made it look quite defensive. Buy, hold or a sell?
Melissa Benson (BUY): We're actually positive on Cochlear now. I think the fact they've signalled a new processor launch - that really tells us internally Cochlear is confident that demand is back after COVID, which had really abated for quite some time. But also, looking at their upgrade cycles and launches, they're getting more and more efficient at reaching back into their installed base, which is now really quite huge. So we think that the services revenue growth they get from that is more efficient than it's been and I don't think the market's appreciating that. And the final other point is just we think there's a really interesting and under met opportunity for Cochlear implants themselves in single-sided deafness, which is kind of a new indication. So we are positive.
James Marlay: Okay, great. Stu, buy, hold or a sell on Cochlear?
Stuart Welch (SELL): I think they're doing a lot of good things in terms of innovating with new products and freeing up capacity in the clinics and what have you. But for us, it's still a little bit expensive. So if you take out the period of ultra-low interest rates, it's still a little bit expensive, relative to its history. If you look at the device sales, so the cochlear implant, the volumes have fully recovered. So I think that the COVID recovery story has kind of played out and I think the most recent result just highlighted that they're not immune to some of those issues with elective surgeries, which I talked about with Ramsay as well. So for us, when you put all that together. For us, it's a sell here.
CSL (ASX: CSL)
James Marlay: Okay. Now is your opportunity. I think there's just one stock in healthcare that you got a favourable view on. So talk us through the thesis.
Stuart Welch: I think CSL is one of those COVID recovery stories. So their core business is collecting plasma from donors primarily in the US, to make treatments for immune efficiency and neurological disorders. And the whole plasma collection side issues are well documented. There were a lot of issues during COVID as donors were fearful of catching the virus and also we had so much stimulus that they didn't need to donate as well. But as that stimulus has been withdrawn and there are inflation pressures, we're certainly seeing a lot more donors coming into the donation centres and those volumes are ramping back up. Whilst that takes some time to come through the P&L, because there is a 7-9 months manufacturing cycle that you got to get through first, we are confident that that recovery is coming. And putting that together, volume recovery together with a bit of price, you can see a return to margin recovery as well. And the valuation there, in a recovery sort of style, is starting to look more attractive relative to its history as well.
Telix Pharmaceuticals (ASX: TLX)
James Marlay: Okay, great. Mel, your chance to pitch us something interesting. What's catching your eye? What's one that you'd like to put a buy on?
Melissa Benson: A buy definitely on Telix Pharmaceuticals. So Telix, it's obviously quite a tumultuous time for them. They've got a new product in the market.
James Marlay: Can you just tell us a little bit about it, I don't know what it does, so maybe give me the one-on-one.
Melissa Benson: Of course. Telix is a radiopharmaceutical company, so that is kind of where you are coupling radioactive isotopes and you're kind of using drugs to hone them into the area for cancer. Telix has a diagnostic side of their business and they also are working on therapies.
So it's exciting for them. They've launched their first commercial product, a prostate cancer diagnostic in the US market. So there's great sales momentum happening there. That's a billion-dollar market that's building very rapidly. But I think what's exciting for Telix, is they've got a second follow-on product in the channel, a renal cancer diagnostic, and we get the phase three readout for that this calendar year. And that really is a very uncontested market and a significant opportunity for them. So if we think about valuation, where it sits right now, in our view it's trading well below the value of just those two imaging assets. And they have a very broad pipeline that includes several therapies that are really huge opportunities. So we think there's definite value here.
James Marlay: Okay, great. Well, ladies and gentlemen, I hope you learnt something new about the healthcare space today from Stu and from Mel. Thanks for tuning in. I hope you enjoyed the episode. Remember to check into YouTube. We're adding fresh content every week.
What's your top healthcare pick?
Stuart and Melissa are bullish on CSL and Telix for the year ahead, respectively. But we would love to know what you think. Let us know your favourite healthcare stock in the comments section below.
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Buy Hold Sell is a weekly video series exclusive to Livewire. In each episode two fund managers give their views 'Buy, Hold or Sell' on five ASX listed companies. Not recommendations, please read the disclaimer and seek advice where appropriate.