Demographic Convergence And The Coming Chinese Healthcare Explosion

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Key Chinese demographic trends portend much higher future healthcare spending.

Government policies, combined with human capital improvements, mean an extremely favorable environment for the industry.

Domestic firms likely to gobble up the majority of future earnings growth.

China is getting old. More importantly, China is going to be getting sick.

The country's meteoric rise over the past few decades has been buoyed by an expanding working age population and low dependency rate. Following the recovery from the "Great Leap Forward", they experienced a massive baby boom in the late '60s and '70s that provided the human capital necessary for the massive economic gains made when those people came of age in the '90s and 2000s. However, that trend is about to reverse.

(Source: Demographics of China - Wikipedia)

Much has been made of the Baby Boomers in the U.S. retiring and the strain that will put on our economic system. The reality is that our population distribution is fairly sustainable, due to immigration and a relatively high birthrate for a developed country.

(Source: U.S. Census Bureau)

The situation in China is quite different. Because of their wild swings in fertility rates and draconian one-child policy, they are about to experience a rapidly aging population for the first time in modern history - with not nearly enough youngsters to replace them.

(Source: ResearchGate)

Many analysts are predicting economic doom & gloom due to this demographic decline, and there is some reason to worry. However, there are also many ways to profit from the predictable changes this shift will bring. The most obvious beneficiary of an aging population is the healthcare sector, due to the parabolic rise in healthcare spending as people grow older.

(Source: Parliament of Canada)

There are many reasons to believe that the upcoming Chinese seniors will not only continue this trend, but spend even more on healthcare than expected. For example, smoking rates in China stood at 2,249 cigarettes per capita in 2014. That was one of the highest in the world, much higher than the rate in the U.S., which clocks in at 1083 cigarettes per capita. Since developing countries tend to smoke less than more developed ones, this figure is quite striking - it's very likely that Chinese people have not even reached their peak cigarette consumption yet.

Another health epidemic that is starting to take hold in China is obesity. Although overall prevalence is still relatively low, the rate in cities is already comparable to that in industrialized countries. As rapid urbanization continues, this trend will only become more pronounced. Diabetes is already a major public health issue, but what we see now is just the beginning of the trend.

(Source: The Economist)

Other factors that will lead to medical problems in China are air pollution, high stress rates, and even the gender imbalance. Given that healthcare spending per capita has already jumped over 2000% in the past 20 years despite a relatively young and healthy population, we can only expect this explosion to pick up even more steam.

As this aging population begins to fall victim to their lifestyles and develop chronic illnesses, they will increasingly turn to the expanding medical coverage offered by the CCP. Under the "Healthy China 2020" initiative, the government aims to complete the transition to universal health coverage. Although the 30-50% copays under their system are quite excessive, the coming generation of seniors will likely have plenty of money to pay for them, since the savings rate in China is extraordinarily high - over 30%.

Clearly, demand for healthcare services is going to skyrocket in the coming decades. But what about supply? Who will benefit from the explosion in this sector? Multinational players like AstraZeneca (NYSE:AZN) and Bayer (OTCPK:BAYZF) have been working on making inroads in the Chinese market for over a decade. Many expect it to account for the majority of their future revenue growth - one indication of this is that China has already surpassed the U.S. in terms of medical sales representatives.

Although there is plenty of opportunity to go around, the lion's share of growth potential is likely to reside with local Chinese companies. One of the reasons for this is continued price pressures. As demand and coverage go up, the government will need to continuously work to keep prices reasonable. This means an inherent preference for generics and biosimilars, which local companies can produce extremely cost-efficiently. Add to this the government's control of foreign investment, and the fact that local companies receive favorable treatment in regulatory matters. This goes double for an industry like healthcare, where the Chinese government actually owns a majority stake in the largest player (Sinopharm (OTCPK:SHTDF)) and the regulatory system is extremely complex and convoluted.

On top of all that, the CCP is ramping up its funding for domestic innovation in the life sciences. Following on the heels of the 12th 5-year plan, where the biomedical industry was one of the seven "strategic industries", the 13th 5-year plan will continue to promote domestic innovation in information-intensive fields and encourage research & development. This focus is made possible by the staggering advancements in Chinese STEM capabilities. Between 2000 and 2011, the Chinese share of global R&D spending grew from 2.2% to 14.5%. This research is supported by an education system that graduates a similar percentage of natural science majors as developed countries like the U.S., Canada, and South Korea - and an absolute number that's off the charts. Shanghai, the most populous city in the world, scores better than any country in the world in terms of math and science proficiency, and Hong Kong isn't too far behind. This will provide a constant stream of highly skilled and reasonably priced talent that could dominate 21st century research-heavy fields in the same way China dominated labor-intensive manufacturing in the 20th century. The country's sheer size means these trends will only become more amplified as their pharmaceutical and biotech companies reach economies of scale that allow them to become multinational players.

(Source: NCEE)

Increasing science literacy will also have demand multiplier effects. As knowledge of scientific principles and the value of western medicine permeates the population, people will be much less likely to accept either traditional Chinese medicine or non-treatment. With both supply and demand outlooks so positive, it's very difficult to envision a scenario without huge earnings growth, barring a political/regulatory catastrophe.

In future articles, I will go into detail about how to best tap the Chinese market, doing in-depth value analysis of both domestic Chinese companies and relevant multinationals.

Disclosure: I am/we are long SHTDF, FOSUF.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.