While the healthcare sector has always been under an investor’s radar, it gains more prominence during times of uncertainties in the local as well as global markets. Healthcare stocks, being non-cyclical and defensive in nature, are the ones investors turn their attention to when an economy is underperforming, and the outlook is looking weak. This is because no matter what the market environment is, health will always remain a priority for individuals. Thus, the demand for healthcare products and services is likely to remain unaffected.

The healthcare sector is a broad sector comprising pharmaceuticals, biotechnology, medical devices & diagnostics, hospitals, medical technology, and health insurance companies. The healthcare sector has consistently outperformed the broader ASX 200 index in the last year, as shown in the chart below:

We will look at the healthcare sector in detail with a focus on how the sector is performing at present and gauge the outlook.

1. Sector Landscape and Outlook

The Australian healthcare system is one of the best across the globe, offering cost-effective and secure services to the citizens. It is broad and encompasses two parts: public healthcare and private healthcare.

Public healthcare system: Government-owned and managed health organisations, public hospitals and community-based services form a part of the public healthcare system.  Through the Medicare system, the government provides a range of healthcare services to the citizens as well the permanent residents of Australia. The government, through the collection of taxes, funds the expenses incurred in providing healthcare services under the Medicare system. The list of healthcare services subsidised by the government is called the Medicare Benefits Schedule. 

Private healthcare system: The system consists of privately-owned healthcare services providers that comprise private hospitals, pharmacies, and specialist medical health. Through private healthcare, patients can avail services that are not included in the public system such as cosmetic surgery or dental treatment. Also, patients have the option of customising their services like opting for a specific doctor or choosing whether to receive treatment in a private or a public hospital.

Role of the Government

According to the Organisation for Economic Co-operation and Development (OECD) data, Australia’s healthcare expenditure (including government/compulsory and voluntary spending) as a percentage of GDP stood at 9.3% in 2018, one of the highest contributions in Asia-Pacific. Further, the government spent ~$9.9 billion on mental health in 2017-18 and provided prescriptions to about 4.3 million patients with mental health issues.

The Australian government (both at the centre and state level) contributed ~68% of the total healthcare spend in the year 2016-2017. The chart below shows a breakup of the $181 billion spent on healthcare in 2016-2017.

Government initiatives for Aged care services: The Australian government offers subsidies for an array of aged care services for older people eligible to avail such services. In 2018-19, the total cost incurred by the government stood at $19.9 billion out of which, 66% was spent on residential aged care services.  Also, over 1,450 organisations received funding for delivering Commonwealth Home Support Programme (CHSP) services.

Through the Home Care Packages Program, the government assists citizens who opt for home care services. The government aims to provide $282.4 million over a 5-year period starting 2018-19 to offer 10,000 home care packages.

Let’s deep dive and unravel the sectors’ current underpinnings.

Current Trends: The healthcare sector is relatively stable, with occasional fluctuations. However, the sector is not entirely immune to the outside environment, and thus, it is dependent on the current scenario around the globe.  Some of the key trends the sector is witnessing include:

• Healthcare companies tackling Coronavirus outbreak: The impact of the novel coronavirus (SARS-CoV-2) has been significant and much worse than initially expected. The virus has led to global slowdown though some of the industries have benefited from the outbreak. The demand for curative treatments such as vaccines, and products offering preventive measures such as masks and hand/surface sanitisers has gone up. This demand has led to companies like Zoono, Biotron and Holista Colltech experience astronomical rise in their respective share price since the turn of the year.
• Cannabis stocks picking up post a muted 2019: Despite a slow 2019, cannabis industry, one of the critical industries within the Australian healthcare sector, has started picking up. The government has had a significant role in it with the legalisation of recreational use of cannabis in 2019 by the Australian Capital Territory. Also, the number of Authorised Prescribers has risen to 62 in February 2020, a significant increase from 33 in the previous month. Further, the Therapeutic Goods Administration (TGA) approved 3,568 applications in February 2020 under SAS Category B.
• Adoption of technology on the rise: Technology has played a significant part in several sectors and healthcare is no different. The use of artificial intelligence (AI) and machine learning (ML), wearable technology, robotics and virtual reality (VR) has been on the rise with companies such as Cochlear, Nanosonics, Volpara and HeraMED continually focussing on novel breakthrough technologies to the market.
• Sustainability concerns for private healthcare insurers: The private healthcare insurance industry has been facing significant challenges including falling healthcare coverage, increasing gap between claims expense and insurance premiums, and increasing number of aged people opting for insurance plans. The industry’s predicament has led to a disappointing December 2019 quarter with gross margin and net margin declining by 1.22 percentage point and 1.32 percentage point, respectively

The sector is on the cusp of making further inroads, time to gauge through the opportunities that are set to unfold for the sector.

Opportunities: The healthcare sector has performed well in the last couple of years, the opportunities are further opening up, thus providing a longer runway for growth opportunities.

• Ageing Population: According to the Australian Bureau of Statistics (ABS), the number of Australians aged 65 years or above were ~3.9 million, or 15.9% of the total population in 2018. This was an increase from 15.1% in 2015 and 14.3% in 2012. It is estimated that by 2031, 19% of Australia’s population will be aged 65 years or above. With a continuous rise in the aged population, there will be an increase in the number of people needing assistance. This, coupled with the fact that the number of carers decreased from 2.70 million in 2015 to 2.65 million in 2018, makes it a significant opportunity for the healthcare players to cater to the needs of all the patients over the age of 65 years.

Figure 5: Factors Affecting Aged Care Services

• Growing prevalence of chronic diseases: Chronic diseases are long lasting conditions with unrelenting impacts. Arthritis, asthma, back pain, cancer, cardiovascular disease, chronic obstructive pulmonary disease, diabetes and mental health conditions are the 8 groups categorised by AIHW. These diseases have a direct impact on peoples’ quality of life. Chronic diseases are becoming increasingly common and thus providing an opportunity for players addressing the needs of these patients.

Figure 6: Chronic Diseases Prevalence and Prevention Plan 

With the understanding of the opportunities unfolding for the players in the sector, now let’s have a look at the outlook for the sector.

Outlook: The future of the Australian healthcare sector will be driven by the growing adoption of technology, changing demographics and government support as well as growth in the cannabis industry.

• Cannabis industry set to become a significant export hub: The Australian cannabis export market is predicted to reach ~$55 billion in the year 2025. The sturdy agricultural sector would drive growth. The Australian government intends to make Australia a powerhouse in exporting cannabis products. Also, there has been significant focus on clinical research with the establishment of ACRE, Australia’s first government-funded research centre to study the safety and efficacy of medicinal cannabis across a range of indications.
• Continual implementation of technology in healthcare: Technology has been playing a critical role in the healthcare sector and companies continue to implement it and offer better products and services to cater to the evolving needs of the patients. Some of the technological trends that have the power of transforming the sector include:
  • Artificial Intelligence (AI) and Machine Learning (ML): Several healthcare companies have adopted AI. These applications have revolutionised multiple processes ranging from drug development to clinical research. Through the implementation of AI, companies are able to address the human errors that can lead to complications or even death. The AI market in healthcare is projected to touch $6.6 billion by 2021.
  • Electronic Health Record (EHR): EHRs include the medical history of patients and aid healthcare providers in their treatment decisions by providing access to evidence-based tools.
  • Cloud Computing: Cloud-based solutions provide enhanced data access data to service providers as well as patients. As a result, healthcare organisations are quickly adopting cloud computing solutions.
  • Telehealth: Telemedicine is critical where healthcare services are not readily available.
  • Blockchain technology: This technology allows specific users to access a patient’s data for a limited period of time and helps keep the patient data secure.
  • Virtual Reality (VR): VR is being used primarily in non-surgical areas such as educating and assisting healthcare professionals or being used as a diagnostic tool.
  • Health-tracking applications: These applications are utilised as personal health assistants and can be used to alert patients when it is time for them to take their medicines.
  • Healthcare chatbots: Health chatbots can provide a range of services including delivering health-related information, help the user set reminders and appointments, and even offer likely diagnosis.
• Government healthcare spending on the rise: According to the Australian government’s budget review for 2019-2020, healthcare spending is predicted to grow by ~2.0% (inflation-adjusted) during the period 2019-20 – 2022-23. Public hospitals and medical services & benefits are likely to be the biggest beneficiaries of the funding.

Figure 7: Total Health Expenses, $ million

1. Investment Theme and Stocks under Discussion (RHC, PME, CUV, MSB, HLS)

After gauging through the key trends, driver and stance, let’s take a detailed view of the companies in the Healthcare Industry in terms of their performance and outlook. To assess the same, companies’ stocks are evaluated based on Discounted Cash Flow (DCF) and Price to Sales.

Fig 11: Relative performance of the stocks under discussion in last 1 year (Indexed to 100)

1. ASX: RHC (RAMSAY HEALTH CARE LIMITED)

(Recommendation: Buy, Potential Upside: 16%)

Valuation

Our valuation model suggests that stock has a potential upside of ~16% on 11 March 2020 closing price. Going forward, the UK and Europe is expected to remain the growth driver for the company, while growth in Australia is expected to remain subdued owing to the aftermath of bushfire. We believe softness in Australian operation is of short-term nature. The group is expected to continue its focus on identifying growth opportunities via organic and inorganic methods.

2. ASX: PME (PRO MEDICUS LIMITED)

(Recommendation: Buy, Potential Upside: 13%)

 Valuation

Our valuation model suggests that stock has a potential upside of ~13% on 11 March 2020 closing price. We expect the company’s revenue growth to remain robust on account of various contracts win in last financial year and first half of FY20.

3. ASX: CUV (CLINUVEL PHARMACEUTICALS LIMITED)

(Recommendation: Buy, Potential Upside: 12%)

 Valuation

Our valuation model suggests that stock has a potential upside of ~12% on 11 March 2020 closing price. We believe that the strategic expansion which the group is considering for its facilities and to further enhance the progress of its drug pipeline would significantly support the group’s top-line in FY20. Also, the Company received a confirmation that the US FDA has designated 29 April’2020 to discuss and agree the North American development program for SCENESSE® for the pigment loss disorder vitiligo. We believe that the expenses made in the first half are expected to facilitate new sources of revenue for CUV in the future.

4. ASX: MSB (MESOBLAST LIMITED)

(Recommendation: Buy, Potential Upside: 13%)

Valuation

We have valued the stock using P/Sales multiple as the company spent a lot of amount on research and development which resulted in negative operating cashflow for the company. However, these expenses generally resulted in long term benefits and put pressure on the near-term profitability. Our valuation model suggests that stock has a potential upside of ~13% on 11 March 2020 closing price. The stock is currently trading at ~9.5x P/Sales (NTM) multiple. We believe that the group continues to trade around 10x of its FY21 sales following a decent success TEMCELL in Japan and expected launch in US post FDA approval where it would gain the first mover advantage.  

5. ASX: HLS (HEALIUS LIMITED)

(Recommendation: HOLD, Potential Upside: 5%)

Valuation

Our valuation model suggests that stock has a potential upside of ~5% on 11 March 2020 closing price. The company has released a decent 1H20 result and long-term outlook remain positive. The group is expected to generate the synergies from the recent acquisitions. However, we believe most of the positives are cashed in at current trading levels. Hence, we have a hold recommendation on the stock and look forward for further growth triggers.

 Note: All the recommendations and the calculations are based on the closing price of 11 March 2020. The financial information has been retrieved from the respective company’s website and Thomson Reuters