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The variety of subsectors in the healthcare sector, from hospitals to biomedical technology to pharmaceuticals – just to name a few – makes it difficult to generalise about ‘healthcare’ as an investment pick. Within the sector, there is opportunity to invest defensively, to target value, and to gamble on the potential for tremendous growth in bleeding-edge technology and novel therapies.

A good defensive buy

George Boubouras, head of investment strategy at UBS Wealth Management, says healthcare stocks belong in an investment portfolio. ‘As a sector, healthcare is a very important part of building a diversified equity portfolio. It’s defensive – and that’s what’s important about it,’ Boubouras says. That is, because of the nature of the goods or services it provides, including hospital treatment and other medical services, the sector is relatively insulated from market volatility and other external economic forces, such as cyclical economic trends.

CMC Markets analyst Chris Weston noted that healthcare stocks enjoyed some immunity from the political turmoil in the Middle East. While major banking stocks fell on the news of civil unrest in Libya, Weston said healthcare was a ‘standout performer.’

Except when it isn’t

While foreign wars don’t seem to trouble the healthcare sector, apparently bad weather does. Primary Health Care managing director Edmund Bateman blamed Cyclone Yasi and the Queensland floods for another downgrade to its earnings guidance this week. The medical centres operator and pathology provider said the natural disasters would result in an $8 million hit to full year earnings – the third downgrade in less than a year.

Despite its recent woes, some analysts were cautiously optimistic about Primary Health Care. Nomura Australia healthcare analyst David Stanton says the worst-case scenario would slice 19 per cent from Primary’s earnings per share in fiscal 2012. In a recent report, Stanton wrote, ‘We believe an improvement in pathology volumes and benefits paid by Medicare through financial 2011 could lead to a re-rating for Primary.’

Steve Johnson, Chief Investment officer of Intelligent Investor, was less bullish on Primary’s prospects. Johnson characterized Primary as the ‘Rolls-Royce of the healthcare sector,’ noting that in 2010 the business generated a return on tangible assets of 40% and its pathology division returned 70% on tangible assets. However, Johnson observed, its pathology division has the Government as its main customer. ‘And that customer is hell bent on reducing its costs,’ Johnson said. ‘For Primary shareholders, the traumas of the past year might only be round one.’

The threat of federal budget cuts has also generally weighed the sector down of late. ‘The reality is there could be significant funding cuts. If there are, returns from the industry will decline,’ says Morningstar senior equities analyst Tim Montague-Jones. ‘If you’re investing $1, you need to know how much revenue you’re getting so you can calculate your return on equity,’ Montague-Jones said. ‘You can’t do that at the moment – they might cut more next year and the year after that.’

UBS’s Boubouras pointed out another vulnerability in the sector. ‘There can be some regulatory risk from time to time. For example, in Australia, since 2007 some federal government changes have challenged the defensive nature of some of those cashflows.’

Tim Savill-Inns of Empire Investing, identifying good stocks for bearish investors, declared that ‘Healthcare should be a winner at all times – no one wants to stay sick and our demographics mean healthcare services and products will be a growth industry for several decades.  However, I am yet to come across an Australian healthcare company that doesn’t have terrible ROE, massive debt or [the burden of] government regulation (think nursing homes).’ Savill-Inns concluded, ‘On the whole, health care will be unhealthy for the bears’ portfolio.’

However, Savill-Inns noted, ‘Cochlear is the one excellent exception to this rule, but it does have some FX risk given more than half of its income is foreign.’  Boubouras likewise tabbed Cochlear as one of his ‘hands-down favourites,’ describing the hearing implant maker, as well as biopharm giant CSL, as ‘sensational, well-managed companies.’

Stellar performance and potential

James Jordan, chief investment officer for Australian ethical, reported standout performance from healthcare sector stocks in his portfolio for the last quarter of 2010. Among the stars were wound healing company Tissue Therapies, which rose 206% in the last quarter of 2010, and Pharmaxis, a pharmaceutical company specializing in products to treat chronic respiratory and autoimmune diseases, which rose 37% of the quarter.

Martin Hession, head of property at Australian Unity Investments, also says the healthcare sector could have a standout year. ‘Offshore investors are seeking to acquire whole portfolios of healthcare properties, which we anticipate will lead to rising property values as competition for assets increases,’ Hession said. ‘In addition, there is active demand from healthcare service providers – particularly for properties that are well located in high profile positions – which contributes to a positive rental income growth outlook.’

Hession also noted the demographic trends favouring the healthcare sector that bolster its position as a defensive buy. ‘Alongside this demand for healthcare properties is the well-publicised increasing need for healthcare services for an ageing Australian society, which in itself helps to guarantee occupancy levels and contributes to yields.’ Boubouras echoed this sentiment, saying ‘an ageing demographic has got good long-term drivers for why people need to spend more on healthcare – on plasma, on private hospitals and other things.’

Thus, as George Boubouras says, you ‘need exposure to healthcare.’ The key is to determine which subsectors will effectively complement your portfolio. One subsector that is likely to see growth in the coming year is healthcare information technology. The Gillard government has allocated $467 million to develop a personally controlled e-health record system to be rolled out next year. PM Gillard and federal Health Minister Nicola Roxon met this week with Dell CEO Michael Dell to discuss opportunities for the global computer company to become involved in the Australian e-health market. Next week in this space, we’ll take a look at the information technology subsector of the Australian stock market.

 

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