Health care is a defensive investment less exposed to the cyclical ups and downs of the business cycle, says one portfolio manager.Ryan Remiorz/The Canadian Press
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Elective surgeries got back on track last year after several years of stop-and-start delays, but a series of headwinds put a dent in the sector’s rebound.
While patients felt it was safe to return to hospitals, burnout and staff shortages limited the capacity for procedures. For medical device makers, inflation was eating into their margins at the same time supply chain problems were disrupting the delivery of parts.
A year later, things have changed for the better, analysts say.
“There were multiple headwinds for hospitals in 2022,” says Tarik Aeta, vice president and portfolio manager at TD Asset Management Inc. (TDAM) in Toronto. “They were under lots of pressure. But those headwinds have basically reversed and become tailwinds.”
Mr. Aeta says shipping costs have come down, semiconductors shortages have eased, and demand for elective surgeries remains strong.
The trends have helped medical technology (medtech) robotics leaders such as Stryker Corp. SYK-N, which focuses on orthopedic surgeries, and Intuitive Surgical Inc. ISRG-Q, which is a leader in general surgical robots. Both have seen strong share price gains this year and hit new highs.
In a recent call with analysts, Intuitive’s chief executive officer, Gary Guthart, pointed to broad-based global demand for critical and elective surgeries. Procedures using its tools rose 22 per cent in the latest quarter, he said. Intuitive shipped 20 per cent more units than it did the previous year of its mainstay Da Vinci SP systems, which assist surgeons. As a result, quarterly revenue rose 15 per cent.
Elliot Johnson, chief investment officer at Toronto-based Evolve Funds Group Inc., says these results indicate a return to pre-pandemic norms after a period when “medtech was on pause.”
“The trend of things becoming better, done better with better machines never actually changes,” he says.
Evolve Global Healthcare Enhanced Yield Fund LIFE-T, which has $208-million in assets under management (AUM), holds both Stryker and Intuitive Surgical. Other holdings include Medtronic Inc., MDT-N, the world’s largest medical device company, and Abbott Laboratories Inc. ABT-N, which makes a range of medical devices and markets generic products such as infant formulas Similac and PediaSure.
Mr. Aeta manages TD Global Healthcare Leaders Index ETF TDOC-T, which has $49-million in AUM and also holds those four companies.
He says the sector has been able to pass along inflationary costs as contracts are renewed.
U.S. hospital employment statistics show staffing is improving, a trend that began last fall. Mr. Aeta speculates this may be due to better pay, incentives to return and more normal workloads. Staff approaching retirement may have discovered that as the cost of living has gone up, they may need more time to save for retirement.
“You’ve had older nurses and physicians saying, ‘I’ll do it for a couple more years,’” he says. “The working environment has improved, COVID-19 protocols have eased. So, it’s a bit more welcoming.”
Mr. Aeta notes that within the health care space, medtech is the best-performing group this year. The S&P 500 Health Care Equipment & Supplies Industry index is up 4 per cent, while the S&P 500 Health Care index is down 2 per cent.
More broadly, Mr. Johnson says the pandemic made health care automation and related technologies more attractive.
“Things that can be done with fewer complications more reliably,” he says.
Mr. Johnson sees the incumbency advantage as a strong energizer for established players. Their systems are expensive and require a lot of training. So, once introduced, it’s easier for customers to upgrade than to replace.
Mr. Aeta says health care is a defensive investment less exposed to the cyclical ups and downs of the business cycle. In good and bad times, people need hip and knee replacements and pacemakers.
“Over the long run, what drives health care growth is demographics and innovation,” he says. “The sector keeps developing new drugs, medical devices and procedures. Over time, that expands the market and the ability of these companies to grow.”
For investors, that means steady growth, recession resistance and secular kind tailwinds for an aging demographic. Emerging markets growth is another energizer.
Both analysts see the sector as undervalued relative to the broader market. Mr. Aeta says the S&P 500 Health Care Index trades at a price/earnings ratio of just more than 17 times forward earnings. The S&P 500 trades at 19 times forward earnings.
“Those three points don’t seem like a big deal, but over the long run, health care has averaged earnings growth of just less than 10 per cent a year, while the S&P has grown earnings closer to 7 per cent,” he says.
“Health care grows over the long run, regardless of whether the economy’s doing really well or really poorly. It has this unique characteristic where it’s defensive, but also does grow earnings faster than the market.”
Adam Mayers is a contributing editor to the Internet Wealth Builder investment newsletter.
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