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In the early morning hours of 18 March in Australia the price of a barrel of oil broke above the $40 level to reach a high for 2016.  This came on another round of speculation that oil producing nations would agree on an output freeze, perhaps next month.

Although the price of oil has arguably been the single most important driver of share market declines across the world in recent months, investors would be well advised that the current uptick in oil remains pure speculation until an actual agreement is not only reached, but honored by all signatories. 

Investors with the temperament necessary to undergo volatile market swings without losing sleep at night would be well-advised to look at sectors beating the downtrend.  One of the major outperformers over the past five years has been the healthcare sector.  Year over year the ASX Healthcare Index (XHJ) is one of only three sectors in positive territory, up about 2% compared to a decline of 12% for the ASX 200.  Over two years the XHJ is up 30% and over five years the index is up 130%. 

Not all healthcare stocks outperform the market.  Some are the stuff of investor nightmares. Prana Biotech (PBT) caught the fancy of investors with the hint of promise from its lead drug as a treatment for Alzheimer’s disease. The drug treatment, PBT2, was in late stage clinical trials in the US when the bottom fell out following devastating results. 

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Prana was well respected and traded in the US on the NASDAQ exchange as well as in Australia. Certainly the failure of the treatment to reach its objectives came as a shock, but was Prana a good bet in the first place?  What makes an attractive healthcare investment?

Let’s look at three of the most successful stocks on the ASX over the last five years – CSL Limited (CSL), ResMed Inc. (RMD), Cochlear Limited (COH), and Ramsey Healthcare (RHC).  The first chart compares CSL and RMD; the second is for COH and RHC over the same time frame.

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While it is quite unfair to attempt an “apples to apples” comparison between a development stage company like Prana and the four stocks with successful products in the market, there is something to be learned here by examining the five against some of the common criteria for evaluating healthcare stocks.

You will find “five things to look for” lists on the Internet, with criteria ranging from solid management, to low debt, to cash reserves, to pipeline, to market potential.  A strong case could be made for pipeline and market potential as by far the most critical considerations.  So let’s attempt to make that case.

Pipeline and market potential applies equally to successful companies like CSL and the other high fliers as well as to development companies like Prana.  Future growth depends on both the number of products in the development pipeline and the stage of development.  Late stage drugs, treatments, or devices will prove their worth far sooner than something at the pre-clinical stage. 

Assuming the company has what appear to be products with promise and the cash to bring them to market, we think a fuller understanding of the marketplace is the key.  What we are suggesting here is that some drugs, treatments, or devices have more revenue-generating capabilities than others.  

Investors can be mesmerized by high sounding medical technologies with breakthrough potential.  But how many people will benefit once the breakthrough comes?  Even for medical conditions affecting large segments of the population, some drugs return more value to their creators than others.  Some drugs are taken daily for the remainder of a patient’s life; others for as little as two weeks. What’s more, drug treatments face stiffer regulatory hurdles than most medical devices.

Competition is another aspect of the marketplace that deserves some research.  In some rare cases a drug, treatment, or device is the first of its kind under development.  In most others, however, there is competition out there with existing products or products under development.  Prana investors enthralled by the prospect of a successful treatment for Alzheimer’s may have failed to notice many other companies were chasing the same goal, without success.

There are analysts of the opinion that medical device manufacturers are, in general, safer investments than biotech or pharmaceutical companies.  Yet even here market potential is key.  A “stand-alone” device is not as valuable to company owners as is a device that requires “consumables” in its operation.  Once a high tech, high cost diagnostic imaging device is sold, the revenue potential to the manufacturer evaporates.  Not so with another successful ASX medical device manufacturer – Nanosonics (NAN).

The company sells a machine that disinfects ultra-sound probes.  The customers are hospitals.  Nanosonics management claims the market potential in the US is 40,000 units with only 4,000 units sold as of mid-2015. However, there are accessories that go with the machine and more importantly, consumable products such as cartridges and medical indicators used in the disinfection process. 

While that sounds appealing; even more appealing are healthcare companies whose products end up directly in the hands of the consuming public.  In truth, that is one common element binding ResMed, Ramsey, Cochlear, and CSL.

Ramsey and CSL could be characterized as providing “consumables” in that consumers, particularly aging consumers, are likely to enter a hospital or require a blood plasma treatment more than once.

ResMed and Cochlear customers are candidates for potential product upgrades.  

All the stocks we have discussed benefit from several major trends in place now and expected to last far into the future.  The trends most commonly cited are the size of the aging population as baby boomers retire and their increased longevity.

There is another trend with perhaps even more potential.  All over the developed world consumers are looking to improve and manage their own health.  The internet provides the opportunity to explore avenues to better health as well as to better understand personal ailments.  

If you are looking for that fabled “next big thing” it may very well be self-diagnostic tools, most notably wearables and smart phone apps.  One of the most successful stocks on the ASX in the last year is getting ready to offer such a diagnostic tool to the masses.

ResApp Health Limited (RAP) found its way to the ASX on 2 July 2015 following an oversubscribed capital raise netting $4 million and a reverse takeover of failed ASX biotech Narhex Life Sciences.  The shares opened and closed the first day of trading at $0.02.  It closed on 17 March at $0.24.

The company has a smart phone app that can diagnose certain respiratory conditions with nothing more than a consumer coughing into the smartphone’s microphone.  Here is how the share price has fared since it came to the attention of investors.

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The app uses a machine learning algorithm developed at the University of Queensland.  The algorithm can both diagnose respiratory conditions and measure their severity.  ResApp has an exclusive license from the university to bring the app to the marketplace.

This might sound like science fiction but the algorithm has already proven successful in a UQ study of 91 patients to diagnose pneumonia and asthma. The results showed 96% accuracy in diagnosing pneumonia and 95% for asthma. A second clinical trial is in progress with results expected to be released in September. Diagnosis of Chronic Pulmonary Disease (COPD) and simple bronchitis is part of the new study.

ResApp operates in the emerging field of Telehealth, defined as the delivery of health-related services via telecommunications devices. On 2 July of 2015 Telstra (TLS) introduced its ReadyCare service which uses smartphones or video calls to allow patients to connect with physicians and show them pictures of whatever their problem is.

ResApp is looking for partners in the growing US Telehealth market where patients can get partial or full reimbursement from some private insurers and partial reimbursement from federal and some state government healthcare reimbursers.  Here in Australia there are no private or public reimbursements for telehealth services.

There are two other companies in the wearable medical technology space serving smaller markets but with the potential to expand.  The first is Catapult Group International (CAT) which focuses exclusively on professional athletes at this time with a wearable device that analyses movement.  The second is Dorsavi Limited (DVL) with three platforms focusing on three distinct markets – ViPerform for professional athletes; ViSafe for workplace occupational and safety; and ViMove for medical personnel and patients to track muscle movements.

Both companies have yet to turn a profit and both have no debt.  Dorsavi may be broader in scope but its share price performance has been no match for Catapult.  Here is the chart.

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Dorsavi began trading on the ASX in December of 2013 after a successful capital raise.  The first day closing price was $0.41 and its most recent close was $0.40 per share.

Catapult came on the ASX on 19 December of 2014, closing its first day at $0.55.  The closing price on 17 March of 2016 was $2.21.  The company is already the global leader in wearable sports analytic devices with 33% of US National Football League teams under subscription along with 20 of that country’s major college football teams.  Catapult also has contracts with Australian Football Teams, basketball teams, rugby teams and others.  

At the moment Catapult has its eyes strictly focused on increasing its presence in the professional athletic domain around the world.  Dorsavi has only two US NFL teams in its stable along with a smattering of US basketball teams and a few Soccer Teams.  But the company recently announced a major contract for its ViSafe platform with the operator of the London underground system, Transport for London.  The ViSafe platform has been available in the all-important US market for less than a year, launching in late April of 2015.  The ViMove platform received FDA approval to expand its use in the US.  UK based YourPhysioPlan signed a three year agreement to sell ViMove in the UK and in Ireland through its network of health and well-being clinics.  

Catapult and Dorsavi feed the data collected by wearable sensors into computers for analysis.  One of the advantages investors might see in ResApp is the fact their approach requires no additional hardware beyond an existing smartphone and an app they expect to market via Android and Apple app stores.  ResApp is in the pre-submission phase for FDA approval in the US, with clinical studies to be conducted in the US part of the approval process.  Despite its impressive share price performance, the risk in investing in ResApp is well-known to many beleaguered device, treatment or drug manufacturers looking to crack the US market – what happens if they fail to get US approval.  Investors appear to be unfazed, perhaps taking comfort in the positive results of the clinical studies already completed on the ResApp application.

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