There used to be a time when healthcare was one of those all-weather “safe” plays. No matter the ups and downs of the economy, healthcare stocks never sank too far. As second quarter earnings are highlighting quite clearly, those days are clearly long past now. Healthcare investors need to hope for real improvement in job and wage statistics if the sector is to grow. Though there is still some leverage to be had in hospitals boosting their capital spending from the unsustainably low levels of 2008-2010, that play has its own expiration date.
Where Have All The Patients Gone?
Take a look at the earnings from companies like Johnson & Johnson (NYSE: JNJ), Bard (NYSE: BCR), and St. Jude (NYSE: STJ) and problems pop out. None of these companies are seeing much real volume growth in their device businesses, as patients are staying home and out of doctors' offices and hospitals. Even at a company like Covidien (NYSE: COV), that is actually doing relatively well, the underlying organic growth is not terribly robust outside of taking share from other med-tech rivals.
It's hardly different at large pharmaceutical companies like Pfizer (NYSE: PFE) or GlaxoSmithKline (NYSE: GSK) – all around the sector, it is the rare company that is able to post more than a few percentage points of volume growth.
Go a step further and look at a company like Stryker (NYSE: SYK) and the nature of the market becomes a little more clear. Stryker is not seeing much growth at all in orthopedic procedure counts (and neither are Johnson & Johnson, Biomet, or Zimmer (NYSE: ZMH), and the volume trends in the surgical tools business is not great either. What was working for Stryker in the second quarter was its patient handling segment – selling beds and the like to hospitals that cut their spending sharply during the worst of the recession and now have to replace obsolete or worn out equipment.
This is a bifurcated market, then. Hospitals have regained enough confidence to spend on big-ticket items like Varian (NYSE: VAR) oncology systems or Intuitive Surgical (Nasdaq: ISRG) surgical robots, but the day-to-day consumable demand is just not there. Hospital numbers are backing this up. When HCA (NYSE: HCA), the huge hospital operator, reported second quarter earnings, same-facility admissions were up less than 2% from last year (which itself was up less than 2% the year before that).
Not Your Parents' Healthcare System
So what do jobs or wages have anything to do with this?
Employer-sponsored (and subsidized) health insurance has long been a valued perk for many employees, but over the past 10 to 15 years it has moved from “nice to have” to “sole source of insurance” for many workers. The reason is quite simple – cost.
The arguments as to why healthcare costs have skyrocketed is a subject for another day, but the reality is that the intermediaries (that is, health insurance companies like Wellpoint (NYSE: WLP) and Unitedhealth (NYSE: UNH)) have had little choice but to pass along higher costs to plan sponsors and employees if they want to continue to be growing, profit-making enterprises in their own right.
That, in turn, has led to higher premiums for employees, much higher premiums for those eligible for COBRA plans, and in some cases unaffordably high premiums for those who are unemployed (and out of COBRA eligibility) or self-employed. Even when premiums are affordable, the rising cost of care and the higher co-payments, and deductibles that go with it, force difficult choices. So too does the feeling among some workers that this is not a job environment where they can afford to take the risk of being out on leave for an extended time to recuperate from a medical procedure.
All of this boils down to a pretty simple conclusion – the state of the economy and household budgets has slammed the brakes on people seeking and consuming healthcare. Given that so many healthcare companies have built their business model around a razor/razor blade plan where they reap the large majority of their profits from disposables/consumables, those low patient counts translate directly into low revenue growth prospects and dysfunctional operating leverage.
No easy answers but to wait it out
Unless investors believe that U.S. job growth (and wages) will never recover, it is fair to assume that these trends will reverse eventually. When that happens, it may be that there is an above-trend surge in patient visits and volume growth as people look to resolve medical issues that have lingered in the absence of insurance coverage or economic security. For true long-term investors, then, this present malaise is an opportunity to pick up solid players like Stryker, Covidien, Abbott Labs (NYSE: ABT), or Pfizer at prices that look appealing over a multi-year horizon. Be aware, though, that near-term organic revenue momentum may be sorely lacking.
For more short-term or growth-oriented investors, the only real answer is to seek out innovation. Intuitive Surgical has the potential to post years of exceptional growth just on the basis of penetrating new surgical markets. Likewise, small companies like Volcano (Nasdaq: VOLC), ICU Medical (Nasdaq: ICUI), and Cardiovascular Systems (Nasdaq: CSII) can outperform on the basis of penetrating lucrative existing market opportunities with new products and technologies. And of course, biotechs can always thrive simply on the basis of introducing a drug that offers some measurable benefit in efficacy or safety, provided they can get by the FDA's gatekeepers.
The Bottom Line
Conventional wisdom can be a dangerous thing when the circumstances change but the sayings remain the same. Such would seem to be the case now for healthcare. While once seen as a stalwart and dependable industry largely immune to the business cycle, the reality now is that many of these companies are critically dependent on sustained growth in patient visits. That patient visit growth, in turn, is dependent upon a healthy job market and reasonable wage growth – meaning that healthcare is now in many ways just another way to play the ups and downs of the job report.