Investment: Should you invest in ... healthcare?
Wednesday 28 July 1999
The medical services sector is perceived as one of the great growth areas for the millennium, so investors might expect these companies to be showing impressive growth. But healthcare stocks seem to suffer through comparison with their more glamorous cousins in pharmaceuticals and biotech.
The factors affecting all three types of company are broadly similar. Richard Moore of Singer & Friedlander says: "During the second quarter, the US market has led more towards economically sensitive and cyclical stocks. The question we are asking is whether we will see a rotation in the third quarter back into consumer stocks."
Mr Moore believes this is likely, but attention will again focus on companies which make drugs, rather than those which supply them. "The relative rating of cyclical stocks does seem to have peaked in recent weeks, certainly in the US, which tends to led global markets," he says. "And the pharmaceutical sector in the US is trading at a p/e of seven : it has been between five and 50 so it is definitely near the bottom of its range."
David Thornton, UK fund manager for the Witan investment trust, adds: "Pharmaceuticals is a huge sector, with several prominent global players, but the healthcare sector is much smaller and more of a mixed bag. So we would follow only one or two companies in that sector."
Investec Guinness Flight's Alan Beaney says: "The industry background is tough. Those in charge of health budgets are under pressure to cut costs and these guys are relatively easy targets. They are not manufacturing drugs with the security of patent protection and a lot are simply supplying commodity- type products. So there has been a lot of pressure on their pricing, which is why a lot of companies in the sector are coming together to cut costs. The two companies which created of Nycomed Amersham were forced to come together and make a virtue out of a necessity."
Healthcare is usually the least attractive of the three groupings for investors, in activities, and size of the companies. Alan Beaney says: "Healthcare is a small sector in the UK these days. It contains only three major stocks - Nycomed Amersham, Smith & Nephew and SSL International."
David Thornton highlights this last named company, following its creation via a merger of two of the sector's more prominent names. "Seton and Scholl were basically two distributors coming together to rationalise their business. Seton was a drug distributor with good management which added on Scholl's product range."
SSL is also taking over another supplier in a different market. Mr Thornton adds: "SSL is looking to do the same thing with London International, since condoms are distributed through the same outlets. It is the same story of improving distribution, rationalisation and cost cutting, but you have to apply a certain degree of caution about whether there has been sufficient time to bed down the original merger. If you back the management's ability to deliver, then they have a very good opportunity to enhance earnings through the London International acquisition, but it is very much a company specific `special situation'."
Mr Thornton also has a cautious view of Nycomed Amersham. "It has effectively undergone a three-way merger, between the old Amersham International and Nycomed, a Norwegian company, with a Japanese company added in later. It is trying to focus on the areas of nuclear medicine and diagnostic products and it is downplaying its old industrial product range. But it is not an easy company to understand because, when you are putting several companies together, it is difficult to see whether it is working or not."
Anthony Milford, manager of the Framlington Health Fund, says: "Nycomed Amersham has one business that looks particularly interesting, genetic sequencing. But, at the same time, the growth from its prostate cancer treatment has slowed significantly. Some people are also warming to Smith & Nephew. I think it is a better managed company now, but is still not really of interest".
David Thornton says: "Smith & Nephew has been a bit of a sleeper. Its performance has been dull over recent years and a lot its prospects rest on the success of its Dermograph product. Growth has been static, but there is confidence things will pick up. And if you take the view that it is a player in a global growth market with a half-decent franchise, the shares could represent good value, if the management can drive earnings forward." Anthony Milford's unit trust, the highest-profile health sector fund in the UK, hardly holds any companies in the UK healthcare sector. He says: "My major interest is in US biotech companies, where there is a lot more activity and there are many companies making profits. In the UK healthcare sector, you have Nycomed Amersham and Smith & Nephew, both substantial companies, but different in what they do. SSL is a reasonable size, but most other stocks are small, nursing homes, the odd hospital and the like."
Alan Beaney cites the nursing home stocks within the healthcare sector as a prime example of how investments in this area can be blown off course by other forces which are beyond their control. "They have been a little hurt by changes in Government policy. We saw a lot of nursing homes floating a few years ago, but there has been much consolidation. The rules have been tightened up on exactly how much local authorities could spend on nursing homes and, following these `privatisations', you have overcapacity as a result."
Investors will have to look at each stock in the sector on its individual merits. Alan Beaney draws attention to the product of another merger, Alliance Unichem. "We like Alliance Unichem, which is a drug wholesaler and whose chairman is Kenneth Clarke. It came about from a merger between Unichem and Alliance, a French-based pharmaceutical supplier, so they should benefit from growing retail demand in the UK and expansion in Europe."
Alan Beaney points out that the sector remains at the mercy of the purchasers of healthcare services. "The sector is fundamentally suffering from pressure to cut costs, in the UK and the US. It is difficult for health services to cut drugs bills, so they go after the suppliers. In this area, purchasers go to preferred suppliers and seek competitive tendering, so prices tend to get squeezed. Smith & Nephew have had a tough time and they are restructuring."
Richard Moore says: "Pharmaceutical companies have much greater scope to grow their earnings than the healthcare providers, since their driver of growth is the development of new drugs and their release onto the market. Healthcare companies are less involved with that and they are more general service providers."
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