No Nasty Surprises Expected In Healthcare Sector

This story features RESMED INC, and other companies. For more info SHARE ANALYSIS: RMD

-Competition focus at RMD, COH and CSL
-Unwinding AUD strength supportive
-PRY, SHL considered solid performers
-ANN needs improved cash flow conversion
 

By Eva Brocklehurst

The consistent theme across the health care sector is the demand support coming from the ageing population. Aside from this, domestic names offer greater earnings certainty in the upcoming reporting season, in Deutsche Bank's view, whereas those internationally focused companies such as ResMed ((RMD)), Cochlear ((COH)) and CSL ((CSL)) have faced increased competitive headwinds.

Deutsche Bank likes Sonic Healthcare ((SHL)) and a strong result is expected, underpinned by an accretive acquisition in Germany and cost cutting in the US. CIMB believes Sonic is a premier pathology company and there is little risk to FY14 expectations, with additional upside via public-private partnerships, both domestically and offshore. Industry feedback suggests to Deutsche Bank that ResMed has pushed hard to regain share in the US but margins are likely to be lower, while CIMB thinks a new platform launch is highly likely over the near term and takes comfort in the acknowledgment that most price adjustments have occurred, and pricing and market stability is being seen.

CIMB recommends picking stocks in lieu of allocating to the sector in general, given disparate business models. Defensive stocks and yield have been the themes in the past year but defensiveness is losing its appeal as the US Fed tapers stimulus, volatility remains low and investors look for better opportunities for capital appreciation. In this environment, with a less than favourable Australian federal budget, the S&P 500 healthcare index has underperformed. The broker expects some outperformance in the index in the months ahead as the Australian dollar's strength unwinds. Where management has used funds to successfully generate earnings growth as a guide, CIMB likes Primary Health Care ((PRY)) and ResMed. The broker thinks Sonic, Ansell ((ANN)) and CSL are fairly priced and Cochlear and Ramsay Health Care ((RHC)) are overvalued.

That said, CIMB suggests FY14 guidance provided by Ramsay is achievable, as growth is underpinned by a strong domestic base and strong operational leverage. The broker also believes the purchase of a majority stake in Generale de Sante is opportunistic and strategic, supporting mid single digit earnings accretion. Deutsche Bank believes Ramsay should deliver a strong result from domestic hospitals while stable funding and robust demand should underpin Primary. CSL and Cochlear face a competitive market, in the broker's opinion, while with Ansell, Deutsche Bank will be looking for proof that acquisitions are on track and there is a pick up in organic growth. CSL has limited upside risk, in CIMB's view, but scarcity value and scope for ongoing capital management means the shares should be supported.

Credit Suisse anticipates few surprises among upcoming healthcare earnings reports. The broker expects Ramsay to deliver the highest earnings growth closely followed by Sonic, ResMed, CSL and Primary. Ansell is expected to be marginally positive, while Cochlear is expected to record substantially negative growth, down around 20% in line with a weak first half.

To become more constructive on Ansell – the broker has an Underperform rating – Credit Suisse requires evidence of improved cash flow conversion and success with the new product strategy. Ansell released 65 new products in FY12 and FY13 and posted just 1.3% organic sales growth. The broker is also looking for new production contribution from Cochlear. Management flagged a significantly stronger second quarter on the back of the Nucleus 6 procession and BAHA 4/Attract releases. CIMB thinks optimism that prior growth profiles can be restored at Cochlear is misplaced and the earnings risk is inadequately reflected in the stock's current trading levels.

UBS also expects Cochlear to underperform, although it may meet the bottom end of guidance via margin gains. The broker suggests the US winter impact may have affected second half FY14 performances for key names such as Sonic, CSL and Cochlear but this potentially recovered in the fourth quarter. The broker envisages some risk from the confusion generated after the Australian federal budget and the proposed GP co-payments but suspects this has largely dissipated. The proposal appears unlikely to pass the Australian Senate in its current form but may be resurrected in another way. Thus, it remains an unresolved policy overhang.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms