By Dominique Montier
The healthcare sector is currently experiencing an unprecedented period of structural change.
One of the rare sectors to display defensive qualities alongside growth opportunities – healthcare is currently benefiting from the convergence of some very interesting shorter-term trends, together with attractive long-term tailwinds.
The positive fundamentals have clearly been reflected in the strong performance for healthcare stocks over the past two years, but many trends are still in earlier stages and valuations remain relatively undemanding. While the P/E of the MSCI World Healthcare Index currently stands at 16.4x, a roughly 10% premium to 14.9x for the MSCI World, this is in line with historic averages and justified due to the compelling opportunity set on offer.
Here are our key reasons for remaining bullish on the near and longer term prospects for the healthcare sector:
Riding the wave of innovation
Perhaps the most significant of the current trends in healthcare is the wave of new product innovation, particularly in therapeutics.
This current innovation cycle in therapeutics is seemingly unprecedented in its strength, driven by biotech companies harvesting the fruits of advances in medical science over the past decade. The most significant of these scientific advances is the mapping of the human genome. This has allowed drug companies to identify the genetic causes of various diseases and to develop medicines specifically targeted at those areas.
Biotech companies have been the primary beneficiaries of this new wave of drug development. The four largest global biotech companies, all of which were essentially start-up businesses in the 1990s, now have a combined market capitalisation of close to $450bn and are expected to generate free cash flows in excess of $150bn over the next five years.
Immuno–oncology, the development of drugs that harness the body’s immune system to treat cancer, also deserves a special mention as it is arguably the most exciting part of new product innovation. Many healthcare investment specialists have commented this is the most exciting medical development they have seen in their careers. This could be the beginning of a paradigm shift in the treatment of cancer. Immuno-oncology will result in a move away from using toxins and towards using the body’s own immune system to control cancer, in the same way it would control other infectious agents such as bacteria and viruses.
Aggressive increase in M&A
Whilst M&A activity has increased across the board in recent years, the healthcare sector is leading the general market with an aggressive increase in M&A volumes. Global healthcare M&A in 2014 was $376 billion, up 92% from 2013. This was without the proposed £69bn takeover bid for UK pharmaceutical group AstraZeneca from Pfizer.
Healthcare M&A is likely to continue as pharma and biotech companies are cash rich and are using M&A as a means to acquire innovation in order to grow their drug pipelines. This is not too dissimilar from general technology companies. Many large groups have decided that the acquisition of smaller biotech and medical devices companies with promising products represents a better return on capital than investing internally in R&D.
We have already seen such moves in 2015, with Britain’s third-largest pharma company Shire announcing its biggest acquisition ever in January with a $5.2bn deal for US biotechnology company NPS Pharmaceuticals. Just this week, UK giant GlaxoSmithKline completed a series of asset swaps worth more than £13bn with Novartis.
The world is getting older
The world’s population is ageing in both developed and developing countries. The population of people aged 60 years and older has doubled since 1980 and is expected to do so again by 2050, with 2 billion people forecast to be over age 60 by the year 2050. This is very relevant for healthcare, as healthcare spending increases exponentially beyond age 50. People aged 75 or older spend nearly three times as much on healthcare are people aged 45 to 54.
A growing emerging middle class
Emerging market countries spend far lower amounts on healthcare as a percentage of GDP relative to developed countries. For example, the US spends 18% of GDP on healthcare – versus 6% for Russia, 5% for China and 4% for India. The UK spends almost 10%.
The direct correlation between healthcare spending as a percentage of GDP and wealth is as a result of two factors. The first is that a higher quality of healthcare is one of the first things people demand once they accumulate wealth beyond what is required for food and shelter. The second is that the incidence of diseases such as obesity, diabetes, and cancer all increase as people adopt more sedentary lifestyles with less healthy diets. In combination, these two factors should result in healthcare spending growing at above the rate of GDP growth in emerging markets.
A more supportive regulator
The primary healthcare regulator, the US’ FDA, has completely changed its approach to working with the industry. Previously it would set exceptionally high standards for new product approval and would penalise any side effects, even for the most serious diseases with critically ill patient populations. It has now recognised that it needs to work more constructively with the industry in order to support the development of products which address significant unmet medical needs.
Dominique Montier is lead manager of the Stenham Healthcare Fund
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