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Health sector tipped to outperform in 2021

Nicki Bourlioufas  |  14 Dec 2020Text size  Decrease  Increase  |  
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Healthcare stocks could outperform in 2021 as vaccines start to roll out globally, with huge increases in government spending expected to support demand for healthcare over the longer term.

This is despite a drop in healthcare spending this year after COVID-19 caused the postponement of non-urgent care in many nations.

Spending on healthcare has been falling in some countries during the pandemic, according to a report from the Economist Intelligence Unit.  But a recovery is expected to gather pace in 2021.

“The battle against the novel coronavirus (COVID-19) has led to a sharp drop in spending on other conditions, with non-urgent care cancelled and patients avoiding hospitals and clinics,” said COVID-19: the impact on healthcare expenditure report. “However, we expect spending on non-coronavirus care to recover later in the year.

“The recovery will continue in 2021, when healthcare spending will rise by 5.5 per cent in US dollar terms. Effective vaccines and treatments for coronavirus are likely to become available during the year, necessitating additional expenditure.”

According to Michael Li, senior portfolio manager with American Century Investments, healthcare stocks have potential for good relative performance based on short- and long-term factors.

“In the near term, the US election uncertainty has largely been resolved, the sector’s more stable earnings are estimated to grow at double digits in the next two years, and healthcare companies as a group are valued at a discount to the market,” said Li.  

“From a long-term perspective, healthcare investors appreciate the significant discovery and innovation in the sector combined with aging global demographics. That combination is driving the capability of some companies to grow at sustained, above-average rates.”

Healthcare encompasses biotechnology, pharmaceuticals, diagnostics, managed healthcare, and medical equipment and supplies, as well as companies engaged in the development, production or distribution of healthcare products or services.

While the market is limited locally, it is high-growth. Companies such as CSL (ASX: CSL) and ResMed (ASX: RMD) are benefitting from greater healthcare spending and chronic disease, with Australian healthcare expenditure growth sitting higher than the OECD media, as the chart below indicates.

Healthcare spending: Australia v OECD

A chart showing healthcare spending in Australia compared to the OECD median average

Source: AIHW Health Expenditure Database; OECD 2018

Before the onset of the pandemic, average health spending as a share of GDP across the OECD was around 8.8 per cent. At 17.0 per cent, it is estimated that the US spent the highest share of GDP on health in 2019, according to the OECD.  In Australia, health spending is around 9.2 per cent of GDP and has been growing at a more rapid rate than the OECD median.

Morningstar director of equity research Mathew Hodge forecasts double-digit compound revenue growth for CSL in the next five years, driven by the immunoglobulin portfolio. “The plasma industry is changing, and CSL is broadening its scope to include emerging therapies,” Hodge says.

And there is momentum for ResMed too, according to fellow Morningstar director of equity research Johannes Faul. ResMed's strategy, which focuses on respiratory devices, sees it well placed to benefit from the major healthcare trends promoting value-based treatment and providing care in lower cost settings, Faul says. 

The company has achieved high growth making devices to treat sleep apnea, considered a chronic condition requiring ongoing management.

Global rise in healthcare spend

According to American Century Investments’ Li, the same factors causing rising healthcare spending in Australia are occurring worldwide, particularly the ageing population. According to the Australian Bureau of Statistics, the age 65 and over group has risen to about 16 per cent of the population and is projected to increase more rapidly over the next decade.

“Global studies show that healthcare spending in that age group and beyond averages about $12,000 per year, which is about three times the amount spent in the younger 20-64 age cohort.

“Second is that healthcare costs continue to rise as new treatments and devices which improve the standard of care are created,” said Li.  

Jason Kritzer and Samantha Pandolfi, portfolio managers for the Eaton Vance Worldwide Health Sciences Fund, said higher standards of the treatment of chronic diseases across nations are also boosting ongoing demand for healthcare.

“Growth in the healthcare sector is led by ageing demographics, innovation and rising global incomes. As the global population ages and becomes wealthier, we believe health care spending is likely to continue to rise. Innovation drives growth in the sector, as increased scientific understanding leads to new breakthroughs,” they said.

“A 65-year-old utilises the healthcare system significantly more than a 25-year-old. People are living longer.  Given the innovation we’ve seen over the last 10 years, more diseases are treated chronically; as a result, many are living longer and dying with a disease rather than from that disease,” which requires ongoing spending, they said.

Pandemic prevention too will also be a key part of the global healthcare spend.  “Healthcare infrastructure will be an important recipient of the increased fiscal spending programs announced across major economies, in order to both upgrade the existing healthcare resources and to ensure that the infrastructure is ready to tackle any future pandemic crisis more efficiently,” said Zehrid Osmani, Head of Global Long-Term Unconstrained Fund at Martin Currie.

“No government … will want to be seen exiting an unprecedented pandemic crisis without channelling large parts of the fiscal spending into upgrading healthcare facilities,” Osmani said. “This will further strengthen the structural growth dynamics that we believe will support the healthcare sector over the next decade and beyond.”

M&A activity expected

More mergers and acquisitions activity is also expected, given cheap as access to funding, particularly in the pharmaceutical sector.

“The healthcare sector has traditionally been subject to significant M&A activity as the innovators that develop drugs and treatments are not always best placed for large-scale production and distribution, which often falls to the larger pharma firms. It can therefore be a highly lucrative space, particularly when you look at the biotechnology industry,” says Kanish Chugh from ETF Securities.

“As we start to see more news on vaccine trials and therapies from other companies in the sector, M&A activity is likely to continue to be attractive. Some companies will be considering how they can bolster their capabilities for any future coronaviruses, but it is also an opportunity to diversify into innovative areas to support chronic illnesses and diseases.”

 

Morningstar's Global Best Ideas list is out now. Morningstar Premium subscribers can view the list here.

See also Morningstar Guide to International Investing.

is a Morningstar contributor.

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