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Greg Bonnell: Many health care stocks are down from the highs put in earlier this year. But according to our featured guest today, the sector may be poised for faster growth than the broader market. Joining us now for more is Tarik Aeta, a global health care analyst at TD Asset Management. Tarik, great to have you on the program. Let’s start there. What’s the thesis? What’s the thinking here that health care could outperform the broader market?
Tarik Aeta: Yeah, so when we take the 10,000 foot view, and even zoom out beyond the investment implications, our personal health is our greatest asset. Good health gives us hope, allows us to pursue our passions, and live life to the fullest. And when you take this back into the world of investing, health care as a result benefits from several attractive qualities, including inelastic demand and strong growth.
And what drives a strong growth in health care is really two very, very simple things. First is a growing and aging global population. Here in Canada, for instance, while population growth is roughly 1% per year, for adults over 65, it grows three times as fast. And as we all age, we all need more health care services. And then the second driver of health care growth is innovation. Just like the technology sector, innovation opens up green space potential for these companies to continue to sell more products over time. Whether we’re looking at transcatheter heart valves, clear aligners, genomics, oncology drugs, many of these products didn’t or barely existed 20 years ago and have since become large revenue generators.
So as the sector continues to invest in research and development, growth in the sector will remain robust for many years to come.
Greg Bonnell: So you’ve got two key drivers there, including of course, we know the aging population and the effect the boomers have had at every stage of their lives, and now that they’re firmly in the golden years. What about the recent earnings season that we saw? What’s the snapshot look like for just the past three months?
Tarik Aeta: Yeah, so overall, earnings were solid for the health care sector. So revenues grew 10% year over year. Earnings were up 9% as well, with 84% of companies beating or meeting estimates. When you look under the hood, the top sector, so industry in the quarter were the pharma companies. So pharma sales grew 15% year over year Pfizer, however, led 80% of that growth thanks to their COVID antiviral. In second place were the health insurers in the US. They grew 14%, driven by strong demand for Medicare Advantage, which is health insurance for seniors over 65. In third place were the life science tools company. They’re benefiting from continued strong demand for the tools and services required to discover and manufacture drugs.
And the one area that did struggle this quarter were the medical device companies. Sales were only up 4%. And that was driven by hospital staffing shortages that held back elective surgeries.
Greg Bonnell: By breaking all that down the way you did, it does give us some insight in the terms. People will say, well, investing in the health care sector. But you start breaking it down by silos, you realize there’s different kinds of companies operating in the space. So how do you approach that as an investor?
Tarik Aeta: Yeah. So as an investor, you just have to look at the fundamentals for each of the different silos. So for instance, when I look at the sector, there are three big buckets. There are companies that are discovering drugs, the companies that are developing widgets, and the companies that are delivering services, what I call the three Ds of health care.
So yeah, for the companies that are discovering drugs, these are your pharma and biotech companies. While the big mega-cap companies do provide a lot of stability, they provide higher than– above average dividends, over the long run, they’ve had a hard time outperforming due to the fact that they’re constantly running on this treadmill of drug and patent expiries.
The second big bucket in the sector are the companies that are developing widgets, so these include the medical device companies, life science tool companies. They benefit from the same sector tailwinds of demographics and innovations that we talked about. But unlike the pharma companies, you don’t take the tail risk of patent expiry, and high risk of R&D. So it’s that you find some higher-quality companies there.
And last but not least, the companies are delivering services. This includes the big health insurers in the US, the telemedicine companies, the hospitals, the dialysis clinic. It’s a bit of a mixed bag over here. But the nice thing about the sector, is there some pockets, like the insurance companies that benefit from some of these secular demographic tailwinds, like an aging population, which is something that does help them over the long run.
Greg Bonnell: Going forward, do we get much in terms of guidance from some of these different companies and the different silos as to how the second half of this year might look?
Tarik Aeta: Yeah, so looking to the full year 2022 guidance. We saw revenue guidance ticking up a touch over the quarter. And then, yeah, when you look at EPS guidance, those numbers came down a touch, driven by margin pressures. So yeah, you have companies like the medical device companies, that their sales grew, but at the same time, their costs went up, including higher wages, higher commodity costs, higher shipping costs. And also, they sell to hospitals on these one to three year contracts. So they struggle a bit.
But yeah, if you look at other companies like the life science tool companies, they benefited, because not only were sales strong, but they were able to pass those inflationary pressures forward to their customers, thanks to the business model where there aren’t these long-term contracts, and it’s easy to pass along those higher prices through higher list prices.
Greg Bonnell: Tarik, when I think about some of the criteria laid out, both of as a space for innovation, obviously, and there’s a great deal of money put into research and development, and of course, the demographics. As the boomers changed everything as they move through society, they changed health care as well. We’re talking really like long term, long focused investing. Like you’re in this sort of for the long haul, if you believe in this thesis.
Tarik Aeta: Yeah, I mean, in health care, you have to invest for long term, just given a lot of these cycles do take a long lot of time. When drugs are discovered and brought to market, I know with COVID vaccines that happened really quickly. But generally, these are long cycles that take many years to play out. And the same thing. When you have new innovations and you’re trying to get adoption amongst health care practitioners, it doesn’t happen overnight. Usually, it’s a couple year process. So yeah, an investor in the health care sector, you need to be long-term focused, and that allows you to really capture those benefits over the long run.
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