Despite recent underperformance in the Australian healthcare sector over the past quarter, we maintain our conviction in its potential to outperform over the next 12 months.
Our confidence stems from four key factors:
- The sector's position as a leader in secular earnings growth
- Its historically defensive nature
- The presence of high-quality companies within the sector
- Favourable valuations vs other defensives
We remain overweight for the following reasons, and we believe the sector can regain its dominance and deliver compelling returns over the next 12 months.
Why healthcare?
1. Secular earnings growth
Healthcare stands out for its secular earnings growth. These companies have consistently demonstrated their ability to grow earnings over the cycle. The sector benefits from structural tailwinds including an ageing population, increasing healthcare expenditures, advancements in medical technology, and rising demand for healthcare services. These trends create a favourable environment for sustained earnings growth, making the sector attractive for investors.
2. Defensive sector
Over the past 20 years, the Australian healthcare sector has demonstrated its defensive nature. During periods of economic uncertainty and market downturns, healthcare stocks have exhibited resilience and outperformance.
Historical data validates the sector's defensive nature, making it an attractive choice for investors in times of uncertainty. In down months, the healthcare sector has, on average, significantly outperformed the market. However, even when the market has performed well, healthcare has, on average, outperformed it, driven by above-market earnings growth.
In the current uncertain market landscape, we believe it is beneficial to hold healthcare stocks. With rising recession risks, defensive sectors such as healthcare offer a valuable safeguard against market volatility and tail risk events.
3. High-quality companies
The Australian healthcare sector comprises a significant number of high-quality companies with exceptional financial metrics. These companies exhibit strong profitability, solid cash flows, and robust balance sheets, contributing to their stability and long-term growth potential. Additionally, quality management teams and global presence further enhance their resilience and growth prospects. The combination of strong financials, effective leadership, and global operations positions these companies favourably.
4. Relative valuations look inexpensive
Compared to other defensive sectors like consumer staples, healthcare stocks appear undervalued, offering an attractive entry point for investors.
When comparing CSL to Woolworths (WOW), CSL has historically traded at a premium. However, the current premium is approaching its lowest point, indicating CSL may be relatively cheap compared to WOW. Given CSL's better growth prospects (21% EPS CAGR1), we prefer to hold CSL at a ~12% premium over WOW (with 7% EPS CAGR*)
*EPS CAGR (FY23e - FY25e)
Stock Selection is Critical
Healthcare offers promising investment opportunities due to its defensive nature and growth potential. The key lies in selecting stocks that provide growth at reasonable valuations, possess defensive qualities, and offer earnings upside.
Certain healthcare stocks experienced remarkable profits during the pandemic driven by increased demand for vaccination/testing centres, masks, and respirators. In our view, the key large-cap healthcare stocks that benefitted from the pandemic are Sonic Healthcare (SHL) and Fisher and Paykel Healthcare (FPH). We believe predicting their post-COVID earnings poses a challenge for analysts, creating potential downside risks to consensus earnings. Until the outlook (in a post-COVID world) is clearer, we remain cautious these stocks.
Growth at a Reasonable Price
Our focus on core stock selection centres around identifying companies that offer growth potential at a reasonable valuation. CSL and RMD fit this criterion. Despite the recent underperformance of these companies, these stocks stand out due to their favourable growth prospects and attractive valuation relative to their expected earnings growth.
While FPH and COH are high-quality companies, we continue to struggle with their valuations when considering their expected growth prospects. Ultimately, in our view you can buy CSL and RMD with similar growth prospects to FPH and COH, respectively, for a lower valuation.
Although TLX has a higher valuation, it also has strong expected earnings growth and the potential for further upgrades to consensus forecasts, which keeps us positive.
Looking for Defensive Healthcare Companies
While the sector itself is already defensive in nature, we have picked the stocks that are more defensive on average (while also selecting stocks that offer growth at a reasonable price).
CSL and RMD have proven to be more defensive than other companies within the healthcare sector. This defensive characteristic provides stability and resilience to the portfolio, making them attractive choices for investors seeking protection during market downturns. The ability to weather challenging economic conditions enhances their appeal as long-term investments.
Some of the Best Growth Stories on the Market
CSL (CSL) 8.5% - Plasma recovery still on track
CSL is the leading player in the global blood plasma industry. The business develops and sells a range of biotherapies and vaccines that treat people with serious medical conditions, and has an extensive R&D pipeline.
The underlying demand for Immunoglobulin (IG) products is acyclical in nature, given it is used to treat patients with a range of serious immunologic and neurological diseases, while the IG market is supply constrained in nature. The favourable supply/demand backdrop for CSL's therapeutics gives the business a high degree of pricing power and underpins defensive earnings through the economic cycle.
- Over the medium-term, CSL should deliver above-market earnings growth with continued growth in plasma collection volumes and a gradual recovery in gross margins to pre-COVID levels, while we also see material earnings upside from expected product launches from Its R&D pipeline.
- There is potential earnings upside in FY24 from the launch of HemGEnix, the first ever gene therapy for Haemophilia B; while in FY25, we see earnings upside from garadacimab, a monoclonal antibody designed to treat patients with hereditary angioedema; and CS112, a novel infusion therapy used to treat Cardiovascular disease.
ResMed (RMD) 3.5% - Phillips opportunity too big to miss
- RMD is the global leader in continuous positive air pressure (CPAP) devices for the treatment of sleep disordered breathing.
- RMD benefits from resilient demand through the cycle and a high degree of customer 'lock-in' due to the non-discretionary nature of CPAP devices (used to treat serious medical conditions) and private/public payer reimbursement support.
- Earnings visibility is high with a meaningful proportion of revenues being recurring in nature, derived from ongoing consumable sales (e.g. masks) and its SaaS subscriptions.
- RMD is poised to experience significant and permanent market share gains over the medium-term on the back of major product recalls from its largest competitor, Philips, which has sidelined the #2 player from the market. RMD has the capacity to fulfill unsatisfied CPAP demand (i.e. previous Philips customers), supporting Wilsons' estimates that RMD's global share will peak at ~75% In FY25 (vs ~56% In FY20).
Telix Pharmaceuticals (TLX) 2% - Large TAM, pipeline underappreciated
- TLX is a biotech that operates in the radiopharmaceuticals space, with both commercial and clinical trial-stage programs focused in prostate, renal, and brain cancer indications among others.
- TLX's first commercial product, ILLUCIX, is a diagnostic imaging agent for patients with prostate cancer. Since its launch in 2022, the success of ILLUCIX In the US market has exceeded expectations, which has resulted in consensus upgrades to estimates around Its terminal market share and the size of Its total addressable market.
- Over the medium-term, earnings growth will be supported by:
- ILLUCIX - a continuation of positive sales momentum in the US market.
- Product launch upside - the next major catalyst in TLX's therapeutic pipeline will be the global launch of its kidney cancer imaging agent, TLX250-CDx, which is expected sometime in FY24.
- ILLUCIX - a continuation of positive sales momentum in the US market.
Written by
Rob Crookston, Equity Strategist
Rob is an experienced research analyst with a background in both equity strategy and macroeconomics. He has a strong knowledge of equity strategy, asset allocation, and financial and econometric modelling.
About Wilsons Advisory: Wilsons Advisory is a financial advisory firm focused on delivering strategic and investment advice for people with ambition – whether they be a private investor, corporate, fund manager or global institution. Its client-first, whole of firm approach allows Wilsons Advisory to partner with clients for the long-term and provide the wide range of financial and advisory services they may require throughout their financial future. Wilsons Advisory is staff-owned and has offices across Australia.
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