Searching for safety in ASX health stocks

Healthcare stocks may provide a haven for investors amid mounting concerns of a global recession, but finding value in the sector could prove difficult, according to Morningstar’s equity outlook report for the second quarter.

Author of the report, Morningstar’s head of equities research for Australia and New Zealand, Peter Warner, paints an uncertain near-term forecast facing investors.

“Financial markets thrive on certainty, however, at present certainty is a scarce commodity.”

While a rate-rise pause from the Reserve Bank of Australia earlier this week came as a relief to some, Warnes says the lagging effects of previous hikes has yet to fully hit the market.

“The full impact of monetary policy tightening is yet to be felt and will continue to affect private sector consumption, particularly that of households,“ he says.

“Corporate earnings will suffer to differing degrees challenging both cash flows and valuations,” he adds.

In light of the challenging outlook, Warnes recommends caution in the near term “until a more certain environment emerges, which may take several quarters”.

Healthcare stocks attractive in ‘shaky’ markets

For cautious investors, Morningstar analyst Shane Ponraj points to the ASX health sector as a potential source of security for investors, with about a third of healthcare companies covered by Morningstar trading in 4- or 5-star territory

“When markets seem shaky, opportunities in healthcare appear particularly attractive,” he says.

“We generally view companies in our healthcare coverage as defensive and fairly insulated from rising inflation or a potential Australian recession due to the essential nature of the products and services provided.”

Ponraj says this generally translates into pricing power, meaning providers can pass on rising input costs to customers without a material impact on demand.

“We also generally do not expect a material negative impact on profits from rising interest rates due to a lack of debt within the sector overall,” he adds.

But finding value among healthcare stocks also appears challenging.

Within Morningstar’s coverage universe, healthcare companies rate among the most overvalued with only a clutch of fairly-valued or undervalued companies available to investors, compared to other sectors.

Companies with a 4- or 5-rating are deemed to be undervalued at the current price, those with a three-star rating are considered fairly valued and those with 1- or 2-star ratings are considered overvalued.

The sector has broadly trended further into overvalued territory over the last year, with Morningstar’s Australia Healthcare Index consistently outperforming the Morningstar Australia Index.

But that doesn’t mean opportunities aren’t available, says Ponraj.

“We view the sector as overvalued on average, but still see buying opportunities with about a third of our healthcare coverage trading in 4- or 5-star territory.”

3 narrow-moat ASX health stocks

In selecting three ASX-listed health stocks to recommend to investors, Ponraj highlighted three narrow moat companies currently trading at either under or fairly valued, based on Morningstar’s fair value estimate.

A Morningstar Economic Moat Rating represents a company's durable competitive advantage over time. A company with an economic moat is expected to fend off competition and earn high returns on capital for either 10 years (in the case of a narrow-moat rating) or 20 years (in the case of a wide-moat rating).

Ansell (ANN)

• Star Rating: ★★★★
• Fair Value Estimate: $30.00
• Uncertainty rating: Medium
  
  

PPE manufacturer Ansell (ANN) is the only stock listed here to carry a four-star or five-star undervalued Morningstar rating.

The company, which develops, manufactures and distributes gloves and protective personal equipment, caters to both the industrial and healthcare sectors.

Ansell is one of just five healthcare stocks in Morningstar’s coverage universe to carry a price-to-fair-value ratio below one, meaning the stock is considered undervalued.

Looking ahead, Ponraj says the outlook for the company is positive as supply and logistics headwinds ease.

“Narrow-moat Ansell shares are undervalued as we anticipate margins to expand. We expect input and shipping costs to ease as supply chains normalise, and pricing for undifferentiated single-use gloves to stabilise lower around pre-pandemic levels by fiscal 2024,” he says.

At around $27 each, shares in Ansell are trading at a near-10% discount to Morningstar’s fair value estimate of $30.00.

CSL (CSL)

• Star rating: ★★★
• Fair value estimate: $315.00
• Uncertainty rating: Medium
  
  

Global biotech CLS has built its reputation on its contributions to the plasma therapies market through its CSL Behring business, but a recent rise in operating costs have hit the companies’ margins, prompting concerns about the growth outlook, but Ponraj says these fears are overblown.

“We think the market is overly concerned about current plasma collection costs and forecast CSL Behring’s gross margin to recover to 57% by fiscal 2025. We expect margins to revert as sales volumes and operating leverage return, and an improving supply environment eases plasma collection costs,” he says.

“We remain optimistic on the long-term trajectory of CSL’s top line, which is underpinned by chronic indications,” he says.

CSL shares are hovering around $300 a piece, compared to Morningstar’s fair value estimate of $315.00.

ResMed (RMD)

• Star rating: ★★★
• Fair value estimate: $35.00
• Uncertainty rating: Medium
  
  

Digital health and medical devices developer, Resmed’s (RMD) flagship products are its cloud-connected medical devices aimed at those suffering with chronic health issues like sleep apnea and chronic obstructive pulmonar disease.

Like many tech developers, however, ResMed operations have continued to suffer under the global semiconductor shortage, which has hampered growth.

However, Ponraj notes that--while ResMed still faces challenges in securing the chips—the firm sees an improving supply chain leading to a positive near-term outlook.

“With conditions improving, ResMed reiterated guidance for quarter-on-quarter revenue growth through fiscal 2023, consistent with our view that supply constraints will progressively alleviate.”

“Given the undersupply in the industry, with Philips severely hampered by its remediation work, we expect ResMed to work through a backlog of orders in 2023.”

ResMed shares are trading around $33.10 and tracking at a slight discount to Morningstar’s fair value estimate of $35.00.

The full Q2 2023 Outlook, which details Morningstar’s best stock picks across all sectors, is available to Investor subscribers.