Friday, February 1, 2013

Emerging Market Health Care Stocks

A number of healthcare companies have reported recently and given better than expected numbers, particularly in emerging markets (EM). Consequently I think this is a key theme to look at and investors should pursue it, particularly as we are in a global economy that is seeing it difficult to generate broad based growth.

GE Reports Good Numbers

The first industrial giant to report good results in the industry was General Electric (NYSE: GE). You can read about the results in more detail here. The key takeaway is that GE’s healthcare division provided the biggest upside surprise in the quarter. GE has been reporting pretty anemic growth in this division for a while now but Q4 saw a 7% increase in equipment orders.

My gut feeling is that within EM there is an upside bias towards government spending on healthcare as a supplement for slowing global growth. In other words, sign off was approved in Q4 whereby in previous quarters there was a more cautious tone to spending. Of course for GE overall this is positive news for its businesses that service infrastructural spending.

Why Emerging Markets Will Spend on Healthcare

Indeed, the BRICs have substantial foreign currency reserves with which they can stimulate their economies. China doesn’t want to repeat the same stimulus program as 2008-09 and certainly doesn’t want to fuel a housing bubble. Nor does it believe that export led growth will be the answer so the near term future looks like it will be about stimulating domestic demand and selected investment in infrastructure.

I think it’s safe to assume areas like healthcare and transportation will be close to the top of the shopping list. The BRICs need to build out social infrastructure in areas that have been developing thanks to overall economic prosperity. Moreover, when China says it expects 7-8% growth, it means it. The Government can just buy this growth with its surplus. In my opinion, this will cause slower problems and slower growth in the long term, but for the next couple of years things should be okay.

Covidien Raises Guidance

Another stock I like in this regard is Covidien (NYSE: COV). I’ve covered it previously in an article linked here, and the recent results saw an upgrade to full year earnings guidance. It is a long stated aim of Covidien to expand its EM sales to around 15% of total revenues by 2016 and, unusually, its EM revenues are not detrimental to gross margins.

Covidien reported double digit growth across regions and product lines and ‘even better’ growth in the BRICs. I think COV has a good opportunity here because its products are not necessarily the most expensive. Indeed, in some cases they offer a tangible return on investment that helps to reduce hospital costs. Specifically, its minimally invasive surgery (MIS) solutions create better patient outcomes and reduce outpatient times. Not only do they have growth prospects in EM, but MIS is also lowly penetrated in certain procedures in the US and according to the company is penetrating 40-45% of hospitals in the US.

A quick look at COV’s medical device sales reveals where the company is generating growth. Recall that MIS plays to its Energy and Endomechanical product lines.

Growth was pretty strong across the board and COV raised its full year revenue forecast to 5-8% growth from 3-6% previously. Some of this is due to raising its expectations thanks to its approval of generic Concerta. Indeed Johnson & Johnson (NYSE: JNJ) recently downplayed expectations for its sales of branded Concerta in 2013. In fact JNJ is a pretty good company with which to think about COV. As I mentioned in that article, JNJ’s surgical sales were pretty good in the quarter and boded well for COV. It’s always good when companies with similar end markets are all reporting the same thing. International specialty surgical sales were up 9.5% in the quarter.

The key Endomechanical, Energy and Vascular product lines recorded 6.7%, 7.8% and 7.0% respectively, and they (along with EM) are the key investment priorities for COV in 2013. The company is highy cash generative but is also committed to investing in its growth categories.
Throw in the spinoff of its pharmaceutical division and ongoing cost efficiencies and there is a good case for COV to fully exploit the growth potential in its products. Other growth drivers include the growing acceptance of MIS in Japan and its strongly performing neurovascular sales.

Where Next for This Theme?

Of the companies discussed, I think Covidien is the most interesting. GE’s healthcare division is not big enough to make a significant difference, and while JNJ is growing strongly in EM its investment case is really about execution, making some divestitures and getting some key consumer products back onto the market. Covidien’s stock price has risen strongly (I sold out after it hit my target) and it is not looking so obviously cheap right now. It’s probably better to wait for a dip. If it comes I will be back in. This is a very well run company.

Investors could also try taking a look at Varian Medical Systems (NYSE: VAR). You can read a SWOT analysis of it linked here. Its oncology numbers were a bit weaker than expected, but this looks to be primarily a European issue and in general orders can be lumpy for larger ticket capital machinery. Provided you can live with the risk of further deterioration in Europe (I'm assuming stable growth this year) then any dip in Varian can also be looked at favorably. The stock has had a great run and, rather like Covidien, it's possible that investors will be looking to take some profits even if it is for short term reasons. In the mid-long term VAR has plenty of good earnings drivers including things like expanding radiation therapy in lung cancer patients.

As for the general theme of EM healthcare spending, I will try to report back on some names later.