Future Returns: Opportunity in Global Healthcare

Typically healthcare “is a more defensive asset,” says David Bailin, chief investment officer and global head of investments at Citi Global Wealth. But the bank is making this bet because “healthcare looks unusually cheap.”

Shares in healthcare companies have risen only by 15% since the end of 2019, including a 5% gain for the year through mid-April—a significant lag to the double-digit gain in the S&P 500 in that time period, according to Cit Private Bank’s April 22 global strategy report. These subdued gains are despite a valuation discount of 25% to the broad S&P 500 index, Citi said.

Also, in the U.S., the sector trades at a 30% forward price-to-earnings ratio discount to the S&P 500, the bank said.

Some of the relative drag on the sector could be related to worries about potential regulation. Proposals mentioned since the Democratic primaries have included regulation of drug prices and an overhaul of the U.S. insurance system, Bailin says.

But, he adds, “talk about actual legislation so far includes increased subsidies to fund long-term care as well as enhancements to the Affordable Care Act subsidy regime—not cutbacks.” There’s also no call for healthcare reform.

“Given that we see the Biden proposal as a ceiling, not a floor, to what can actually be passed in the current Congress, we view the odds of major healthcare regulation that would constrict the growth of healthcare revenues as lower than what the market is currently pricing,” Bailin says.

The reason to tilt to healthcare is to gain exposure to global growth, exposure to stocks with high dividend yields, and exposure to what Citi views as an “unstoppable trend”—the demographic shift within many countries to older populations that have the money to spend on the healthcare they increasingly need.

Penta recently spoke with Bailin about where the opportunities in healthcare are.

Why Is Healthcare Undervalued?

Healthcare historically trades at a lower valuation to the market, but always at a correlated lower valuation. Since the market bottomed in March 2020, however, stocks have been driven to lofty levels by growth sectors, such as technology—a trend that stumbled on Monday as the Dow sank 500 points.

But during this period, over the last 15 months, healthcare stocks “did not inflate,” Bailin says. Their valuations remained “within a channel of normality,” yet relative to everything else, they’re “under-appreciated,” he says.

One interesting note about healthcare is that the sector hasn’t ever had a down year in revenues or earnings—even during the years of the financial crisis, 2008-09—since the late 1980s. “How much would you pay for that consistency? Right now, you’d pay a lot,” Bailin says.

Also, the bank’s strategists note in the April report that the sector has not been a bad place to be when markets slide. “Healthcare has historically fallen the least among market segments during corrections,” the report said.

Which Sectors to Focus On? 

In terms of specifically where to invest, Citi wrote that “the long-term case” for spending on healthcare “rests on aging demographics, rising income levels in emerging market countries, and tremendous innovation in vaccines, gene therapy, med-tech, wearables, Alzheimer’s treatments, and much more.”

One company that will benefit from current demographic shifts, for instance, is San Diego-based Dexcom, which develops, makes, and distributes monitoring systems for diabetes.

Biotechnology and biopharmaceutical companies also should benefit, given the important role these companies play in drug discoveries and treatments.

To capture global growth—and high dividend yields—Citi recommends companies such as Chicago-based biopharmaceutical AbbVie (with a 4.5% dividend yield), and companies listed on exchanges outside the U.S., where stocks are slightly less expensive, Bailin says. An example of the latter is Paris-based multinational pharmaceutical company Sanofi, which also has a high dividend yield of 3.7%.

Citi also likes companies creating healthcare delivery systems, such as telehealth—services that allow patients to interact virtually with their health-care practitioners.

“There are a whole bunch of companies that are changing the delivery modality to moving away from the hospital and away from the office,” Bailin says. “We think this will happen with many sectors.”

Also worth a look are companies involved in medical devices, robotic surgery, or “anything that creates better decisions,” he says.

Intuitive Surgical, for example, is the leader in robotic-assisted surgeries, Bailin says. It “continues to expand into new surgical indications, and the [total addressable market] is enormous.”

In the wake of the pandemic, Bailin expects some pharmaceutical companies and companies focused on physician-administered therapies and vaccines will get a boost temporarily as people return to the doctor for the first time in more than a year.

“Instances of disease are lower, but it doesn’t mean they actually are lower—they are just not reported,” Bailin says. “We have a bunch of catch-up over the next 12-to-24 months to [get] back to baseline interaction with healthcare providers.”

New Jersey-based Merck, for instance, could benefit “given that its oncology and vaccines are a significant percentage of revenue,” he says.

What About Technology? 

While the technology sector had a bad day on Tuesday as the market rotated out of growth stocks, investors may not be ready to abandon hot tech names just yet. In announcing the tactical shift higher in healthcare, Citi noted that investors who followed their recommendation would still have plenty of exposure to technology.

Investors who follow Citi’s recommended 60% allocation to global stocks as defined by the investable MSCI All Country World Index will have 12.6% of their portfolio invested in technology, according to Citi. The recommendation to increase healthcare to a 4% overweight will lead to an 11.2% exposure.

“For decades the sector has carried some modicum of political and headline risk,” Citi wrote. “But that has yet to upend an enviable record of positive revenue growth. Steady revenue growth at a deep valuation discount is the type of script we like.”

Reprinted by permission of Penta. Copyright 2021 Dow Jones & Company. Inc. All Rights Reserved Worldwide. Original date of publication: May 11, 2021