While our hunt for value is always a bottom-up endeavor approached on a stock-by-stock basis, there are times when value clusters and we find a bevy of holdings in one area. In recent years, our team has taken advantage of dislocations in the health care sector, where controversy around prices and political uncertainty have created some opportunities for those willing to look out over the horizon and think long term.
Many believe health care has become a socioeconomic burden on consumers, with rising drug prices viewed as the main driver of escalating cost inflation. In reality, pharmaceutical spending is nearly the same as in 1960 – representing an estimated 10% of total healthcare expenditures. By contrast, the percentage of healthcare dollars spent on hospital visits is nearly three times the amount spent on medication. However, given its high profit margins, pharmaceutical names have become an easy target for backlash. Nonetheless, we believe the underlying fundamentals and competitive advantages of high quality and uniquely positioned pharma, therapeutic and medical-care-related companies will continue to grow.
Demand for health care is on the rise. Under current insurance regulations, preventative care is no longer a luxury, it must be provided. Patients that receive annual physicals tend to use more preventative medications and supplements. Moreover, as the population ages, health systems are seeing higher patient volumes that require more extensive drug treatments and medical care. Sedentary lifestyles, poor nutrition and rising obesity levels have also resulted in an increased need to treat issues such as diabetes and other chronic illnesses. Not to mention, the list of areas where opportunities for medical advancement exist are endless: Alzheimer’s, cancer, heart disease, multiple sclerosis and schizophrenia mental health, to name but a few. In our view, preventative maintenance screenings, medication management and innovative drugs are an important thesis for preventing higher cost hospital utilization. Against this backdrop, differentiated companies that are tangential to preventative care and those that offer high quality, cost-efficient as well as groundbreaking pharmaceuticals, therapies and medical care should be seen as part of the solution, not part of the problem. On this point, Bio-Rad Laboratories Inc. (BIO, Financial), Laboratory Corporation of America Holdings (LH, Financial), Thermo Fisher Scientific, Inc. (TMO, Financial), Johnson & Johnson (JNJ), GlaxoSmithKline plc (GSK, Financial), Roche Holding AG (ROG, Financial), Gilead Sciences, Inc. (GILD, Financial), Cardinal Health, Inc. (CAH, Financial), Zimmer Biomet Holdings, Inc. (ZBH, Financial) and Hanger, Inc. (HNGR, Financial) stand out – and yet, their potential remains under-appreciated by the market.
Furthermore, we believe valuations of health care companies that focus on cost optimization, as well as those that promote efficiency across the supply chain by utilizing technology will also be rewarded over the long term. By reducing redundancies and eliminating waste in areas that affect patient care the least, companies will effectively lower costs and boost overall financial performance.
Meanwhile, the barriers to entry, particularly the cost of research and development are prohibitive. As a result, margins and returns on capital are generally high. As such, balance sheets across the sector are solid, with many companies generating a significant amount of free cash flow, increasing the possibility for higher dividend yields, share-enhancing stock buybacks and industry consolidation.
So while our health care names may experience short-term dips related to concerns over drug prices and regulatory worries, the risk is priced into our current valuations. In the interim, with demographic and secular trends, as well as strong corporate financials on our side, we will continue to take advantage of opportunities and patiently wait for the investment community to realize the value of our high quality and uniquely positioned health care holdings.
The opinions expressed are current as of the date of this commentary but are subject to change. The information provided in this commentary does not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular security.
