Negative sentiment over the sector is providing the chance to pick up quality companies at attractive valuations.
The ailing healthcare sector was one of Europe’s worst performing sectors – over the last year, the MSCI Europe Health Care Index underperformed the MSCI Europe Index by 10.13. Regulatory changes and costly infrastructure spending have contributed to shrinking margins and rising costs.
However, while there are headwinds, there are also plenty of opportunities; particularly in shifting demographics and the increasing longevity of our lifespans. The negative sentiment hanging over the sector is also providing compelling opportunities to pick up quality companies at attractive valuations for contrarian investors like ourselves.
From proton therapy to ostomy solutions, I discuss four unloved stocks providing solutions to the challenge of sustaining a better quality of life for the world’s greying population.
ConvaTec is one of the world’s largest players in ostomy care – surgery performed to create an opening in the body for the discharge of waste – where it operates in a structurally attractive oligopoly. It is also the third largest global player in advanced wound care – dressings to treat acute and chronic wounds.
ConvaTec’s share price has been weak since June 2017, due to concerns surrounding the execution of a widely anticipated ‘Margin Improvement Plan’, manufacturing issues in transferring a plant from the US to the Dominican Republic, which disrupted the supply chain, and a profit warning in October that put further pressure on the stock.
However, this is a business with strong competitive advantages. In wound care, it benefits from the market’s high barriers to entry and low risk of disruption from new players due to the strength of its brand and the relationships it has built with healthcare professionals. In ostomy, ConvaTec benefits from a very sticky customer base as switching rates tend to be low due to the sensitive nature of such products.
Growth in wound care is driven by lifestyle changes – as many chronic wounds are directly or indirectly caused by obesity – and an ageing population, given increased surgery amongst this segment of the population. In ostomy, the prevalence of bowel diseases increases with age, which is driving growth in this part of the market.
Despite the temporary setback, the long-term outlook for ConvaTec is very strong, supported by attractive financials – high returns and profit margins and significant free cash flow.
Spire Healthcare plc is one of the UK’s largest private hospital providers, with 39 hospitals and 12 clinics across the country. But 2017 was a turbulent year for Spire. It suffered a profit warning in September, in response to lower NHS activity following the removal of the 18-week waiting list target. A failed bid by South African hospital group Mediclinic in October put further pressure on shares.
With NHS budgets and resources under severe pressure and as the UK’s demographic profile changes with population aging, the UK’s independent hospital sector has an important role to play offering private treatments and taking on NHS patients. In the UK, it is projected the >65yr age group will increase from c18 per cent to 28 per cent by 2050.
For Spire, the ‘self-pay’ segment of the market is growing rapidly, with those in the over-50s age bracket typically opting to pay for treatment to avoid lengthy waits. Spire is the number one player in this industry and should be well positioned to capitalise on this trend.
A new management team with a strong vision for the future of Spire provided us with an attractive entry point into a high-quality business with solid long-term prospects.
Ion Beam Applications
Proton therapy is a type of cancer radiotherapy deemed superior to conventional radiotherapy due to its better treatment efficacy and the minimisation of exposure to healthy tissue due to the fact there is no exit beam. With cancer being the leading cause of death in the developed world and as cancer rates rise dramatically in +55yrs old, the oncology market is set to continue to grow as companies continue to find ways to treat the disease.
Ion Beam Applications (IBA) is the market leader in proton therapy – with about 50 per cent of the global share – in this structurally attractive, oligopolistic market, which is expected to grow at a 15 per cent CAGR to 2035. Belgian-listed IBA delivered four profit warnings in 12 months, mainly due to delays in the construction process of its complex systems, which has caused the share price to more than half.
Despite these short-term, cyclical headwinds, the company benefits from high barriers to entry, a strong backlog equating to over €1bn of sales and a rock-solid balance sheet which can support future growth.
Vectura Group is a leader in the development of respiratory products, including treatments for asthma and Chronic Obstructive Pulmonary Disease (COPD) aka ‘smoker’s cough’ – the fourth leading cause of death worldwide with increasing prevalence particularly in the elderly. The development of inhaled drugs requires the interplay of the following three factors: the drug, the formulation and the device; thus, it is a complex field, in which Vectura is a global leader with a very strong track record.
Its technology is embedded in half of new inhalers launched from 2012 to 2016, demonstrating it is the partner of choice for targeting airways. Shares have been weak due to delays in obtaining FDA approval for its generic version of GSK’s blockbuster Advair drug. We could therefore see a substantial positive impact on its top line when this finally launches into the market.
Given its business model, which consists of receiving royalties on inhaler sales, Vectura has high revenue visibility and currently trades below the NPV of the current portfolio. This means investors are getting the pipeline for free at today’s share price.
Claire Shaw is manager of the OYSTER European Mid & Small Cap fund at SYZ Asset Management.
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