It pays to look overseas for investment opportunities in some sectors more than others. Healthcare is an example. A lack of large healthcare stocks on ASX limits choice and arguably inflates their valuations compared with overseas peers.
At $128 a share, Cochlear trades on a forecast Price Earnings (PE) multiple of 29 times FY18 earnings, using consensus analyst forecasts. Global medical-devices giant Medtronic Plc is on a forward PE of about 15 times FY18 forecast earnings, at US$74.44 a share.
Cochlear, a great company, is a fraction of Medtronic’s size and does not have its product or geographic diversity. Yes, Cochlear deserves to trade at a significant premium to the Australian average, but should its valuation multiple be almost double that of Medtronics?
The same is true of Ramsay Health Care, another fantastic Australian healthcare company. Ramsay trades on a forecast FY18 PE multiple of 22 times, using consensus estimates. HCA Holdings Inc, the largest private-hospital owner in the US, trades on a forward PE of 11.2.
Cochlear and Ramsay are not alone. Several well-performed Australian healthcare stocks trade on valuation multiples that are considerably higher than those of their offshore peers. Put another way, Australian investors are paying more for local healthcare stocks, which, in many cases, have greater risk because of their narrower product and geographic focus.
Do not take that as a criticism of Australian healthcare stocks. Ramsay and others have rewarded their shareholders handsomely over many years. But successful investors obsess about value and in healthcare it is often more compelling overseas.
Nevertheless, finding value in the global healthcare sector has been hard work in the past few years. Investors know that an ageing population, technology advances and the emergence of the Asian middle-class are great tailwinds for healthcare and have priced stocks accordingly.
The ASX-quoted iShares Global Healthcare Exchange Traded Fund (ETF) has starred with an annual return of 21.4 per cent over five years to December 2016. Having identified this ETF for The Bull in late 2013, I am pleased with the results.
Chart 1: iShares Global Healthcare ETF over five yearsSource: The Bull
But after soaring for several years, the iShares healthcare fund is in retreat. The ETF lost 5.7 per cent in calendar year 2016 and is down almost 4 per cent this month. Donald Trump’s surprise United States election win has put shivers through global healthcare stocks.
Chart 2: iShares Global Healthcare ETF over two yearsSource: The Bull
Trump’s key healthcare policy goal is to repeal and replace the US Affordable Care Act, better known as “Obamacare”. The Affordable Care Act allows millions of newly health-insured Americans to visit hospitals; without it, hospital occupancy rates and earnings could fall. Device manufacturers that sell to hospitals would also suffer.
At the same time, Trump has pharmaceutical companies in his sights. Repeated warnings that he will bring down drug prices weighed on the share prices of large pharmaecuticals. CSL could be among the few winners if a Trump government created free-market drug pricing – a big ask given the US pharmaceutical industry’s lobbying power.
Trump is making good on his election healthcare promises. One of his first Presidential executive orders this week was to urge government departments to ‘waive, defer, grant exemptions from, or delay the implementation’ of provisions of the Affordable Care Act.
Investors need to ask if the market has over-reacted to Trump’s healthcare plans, given the extent of share-price falls this year and last. Make no mistake: Trump adds uncertainty to the sector and price falls were warranted. But the selling looks a little overdone.
I favour the iShares Global Healthcare ETF for a few reasons. First, it is based on an index of 1,200 healthcare stocks worldwide. This diversification helps reduce risk if Trump takes a bigger axe than expected to aspects of the US healthcare system.
Second, about 70 per cent of the index on which the ETF is based, by market capitalisation, is in pharmaceutical, biotech and life-science stocks. The rest is in healthcare services and equipment. Also, about a third of the index is invested in non-US companies.
Third, the ETF is unhedged for currency movements. A lower Australian dollar relative to the US dollar this year, which I expect, would lift returns in the ASX-quoted ETF. Do not count on big falls, but the Australian dollar’s outlook strengthens the case to invest offshore.
Finally, the ETF is down almost 10 per cent from July 2016. It will fall further if Trump’s rhetoric continues to spook US healthcare stocks and if policies, which will take some time to enact, lead to significant declines in hospital usage in the US and in earnings.
There is a view in the US that Trump’s healthcare plan will eventually be watered down and that it might not affect earnings of hospital and pharmaceutical companies as much as feared. If so, recent price weakness is a buying opportunity.
Nevertheless, investors might stand aside until the volatility subsides and put the iShares Global Healthcare ETF on their portfolio watchlist, in anticipation of better value.
Chartist and active investors will look for the ETF to hold price support at $120. If it breaches that level, further falls are likely, based on technical analysis.
For all the short-term risks, healthcare is a great long-term sector for portfolio investors and the ETF’s average PE multiple of 21 is less than that for many large Australian healthcare stocks. The trick is to be alert for when irrational market sentiment drives prices too low in the global healthcare sector.
Tony Featherstone is a former managing editor of BRW and Shares magazines. The information in this article should not be considered personal advice. The article has been prepared without considering your objectives, financial situation or needs. Before acting on the information in this article you should consider its appropriateness, regarding your objectives, financial situation and needs. Do further research of your own or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at January 25, 2017.