IBBQ - Outlook For Healthcare Sector As Obesity Drugs Gain Popularity

2023-08-16 02:28:00 ET

Summary

• Risk-on sentiment and end of pandemic boom have weighed on healthcare.
• Health insurers and medical device firms have held up better.
• Growing opportunity in obesity treatments.

Tarik Aeta, Global Healthcare Analyst with TD Asset Management joins MoneyTalk’s Greg Bonnell to discuss the outlook for healthcare stocks.

Greg Bonnell: Now, despite excitement around new treatments for issues such as obesity, healthcare stocks have lagged the wider market so far this year.

Joining us now to discuss what's happening in the sector, whether it's poised for better growth ahead, Tarik Aeta, global healthcare analyst with TD Asset Management. Tarik, great to have you back on the show.

Tarik Aeta: Yeah, thanks for having me here.

So I recall, the last time you were on the show in January, you had some skepticism about whether healthcare could continue the strong run it had last year. And indeed, it has not continued that run. What's playing out in the space?

Tarik Aeta: Yeah, so there's been two things really that have held back the healthcare sector this year. So first of all, if we run the clock eight months ago back to December, sentiment and equity markets were pretty low. But as the first two quarters of the year unfolded, the US consumer has held up very well, corporate earnings have held up very well. And as a result, we've seen the S&P and NASDAQ recover.

And under the hood, we've seen investors sell off defensive names like healthcare, consumer staples and utilities, and rotate into technology, consumer discretionary, as well as communication services, including the big FANG names. So that's the first thing.

And the other thing that's really held back healthcare this year has been weak financial performance as we exit the pandemic. So a lot of the sales from COVID vaccines, and therapeutics, and tests, and vaccine manufacturing equipment, all of that, we're lapping these very tough comps from last year. But that process is nearing the late innings. And the sector is digesting those headwinds.

Greg Bonnell: OK, so a few things to play on the larger scale. How about the earnings season? I think we just wrapped up pretty much all of the big names for the most recent quarter. How has it looked?

Tarik Aeta: Yeah, so earnings season for healthcare was soft, as expected. So earnings were down 14% year over year versus the S&P 500, where earnings were only down 5%. So healthcare definitely lagged. And as mentioned before, a lot of that is due to the loss of vaccines, therapeutics, testing, vaccine manufacturing equipment.

But when we look under the hood, there's been a couple areas of strength and a couple areas of weakness as well. So one area of strength has been the US health insurers. They saw earnings increase 11% year over year. That said, it's been a bit of a deceleration. They have seen higher claims as elective surgeries have resumed and have come back in greater numbers.

But that said, it was better than expected. And they're also getting a bit of a tailwind from higher interest rates, which is generating higher income on their investment portfolios.

Another area of strength this quarter were the medical device names. So they saw earnings up 8% year over year. And that's, again, driven by elective surgeries returning, hospital staffing improving, cost of goods sold to manufacture those medical devices have been coming down recently as shipping costs and commodity prices have been coming down. So they've benefited.

And in terms of the weak spot, it's a lot of the stuff we mentioned already. So one, life science tool companies, they saw earnings down 15% driven by lower testing and lower vaccine equipment. And then the pharma and biotech companies saw earnings decline 25%, mostly driven by Pfizer (PFE) and Moderna (MRNA). But we also saw weak results out of AbbVie (ABBV) due to the patent expiration of Humira earlier this year. So that's also been another pressure on the sector there.

Greg Bonnell: You mentioned hospital staffing levels. Let's talk about that a bit. Because to someone who's an outside observer, they might say, well, hospital staffing levels will mean this for the entire healthcare service. But as you get into it, you say, no, it means different things for different parts of the sector.

Tarik Aeta: Right, exactly. So yeah, so over the past two years, hospital staffing has been a big topic in healthcare. And if we run the clock at the beginning of the pandemic, a lot of doctors and nurses either got burnt out and dropped off, or either were worried about the virus and dropped out of the labor market. And that had a lot of impacts.

The insurers were overearning for two years, given you had fewer claims. The hospitals were having -- were having to pay up for temp labor that was more expensive. And the medical device companies saw fewer elective surgeries, which hit their revenues. But fast-forward to today, things are actually very different in the last 12 months. Hospital employment is now 4% higher than where it was pre-COVID. Healthcare has been the largest driver of job creation in the US in recent months. It's been accounting for over a third of all jobs.

And then even beyond that, we're looking at stats like pricing for temp agencies for nurses. Those have been coming down as more nurses return back to the labor market. And also the one dynamic no one really anticipated a year ago is that due to the higher inflation environment, higher interest rate environment, we're seeing a lot of doctors and nurses delay retirement. And that's driving higher supply of labor and also helping with these supply shortages.

Greg Bonnell: OK, interesting dynamics at play there. So you've nicely sort of laid out, after a strong year last year, some of the big themes of play that have held healthcare back. What about going forward? I mean, what are you most constructive on and what are the areas you might be a little more cautious on?

Tarik Aeta: Yeah, so definitely going forward, I am more constructive here. I would say the one area I'd be a bit more cautious are the medical device names. So since last summer, we've seen elective surgeries return. And investors have positioned accordingly in these names. And they've done very well over the past year. So a lot of these names are great names. But they had a really strong run the past year -- names like Stryker (SYK), Intuitive Surgical (ISRG). And I just have a hard time seeing that strong outperformance repeating.

In terms of where I'm more constructive, I'd call out two areas. So first would be the health insurers. Earlier in the year, there were a lot of concerns regarding changes in Medicare Advantage reimbursement. They were concerned that these higher utilization rates would dampen earnings this year. But a lot of those tail risks have been priced into the stock and have been better understood by investors.

So on a go forward basis, I think a lot of the bad news has been flushed out. And then the other area I'm more constructive on over the upcoming year are the life science tool companies. So yes, we know that COVID testing has come down. We know that vaccine manufacturing demand has come down. But as we go into next year, earnings for these companies should accelerate as you have strong underlying demand from biologic drugs across the board.

And then in terms of the pharma and biotech names, again, you had a lot of COVID headwinds this year. But going into next year, we have really big tailwinds from continued growth in cancer, obesity, diabetes. And that should drive strong results for that group going into next year.

Greg Bonnell: Let's talk about diabetes. Let's talk about obesity. There obviously has been a lot of talk and excitement this year. Those drug commercials are always the same. They're always some sort of scenario, they're like ask your doctor.

And at one point, I was like, what is this Ozempic stuff anyway? So I actually did try to figure out what was going on. A lot of talk around them. What's actually happening in the space?

Tarik Aeta: Yeah, so I do think that the hype here is real. And maybe taking a step back, GLP-1 drugs are basically a class of drugs that reduce appetite, make your stomach empty more slowly, and overall, will just make you eat less. And originally, they were designed for people with type 2 diabetes and to help them better control blood sugar over time. But they did discover that one of the side effects of this drug is people would lose weight.

So what you saw a couple of years ago is that Novo Nordisk ran trials to show that this drug can be used in individuals with obesity. And then the results from this trial were successful. So they had a higher dose of Ozempic called Wegovy and that drove 17% weight loss. And the reason that's an important number is that if you go three years ago, the best weight loss drugs at the time would only deliver 6% weight loss. So this is a big step change in terms of weight loss from this newest generation of GLP-1s.

And as well, Eli Lilly (LLY) has a similar drug on the market, Manjaro, that drives 21% weight loss. And we're now basically in the zone of where bariatric surgery used to perform, which would be 20% to 30% of weight loss. So these drugs are definitely very effective.

And then when you look at the demand globally, the demand is very large. You have 700 million individuals globally that are dealing with obesity. And 40% of American adults are obese. So there's definitely a very big unmet need. And over the upcoming decade, between the demand for type 2 diabetes as well as obesity, I wouldn't be surprised if this drug class can reach upwards of $100 billion of sales annually. So definitely a big development.

And really, the big bottleneck now is just getting more supply. So Novo Nordisk (NVO) is talking about having more supply later this year, as well as Eli Lilly. But just given how big the demand is, it's going to take several quarters, if not even like two years, to get all these supply bottlenecks behind us.

And also the other big element to watch out for is government reimbursement. Events like last week, with Novo's SELECT trial, which showed that in addition to weight loss, these drugs also reduce the risk of cardiovascular events by 20% helps in making the case -- in getting these drugs reimbursed and helps make the case beyond just cosmetic weight loss.

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