The healthcare sector is in the spotlight in 2021 as every citizen, in every country, pins their hopes on Big Pharma delivering a fast and effective solution to the COVID-19 virus.
Just 12 months after the global pandemic began, the fastest and most coordinated effort ever undertaken by drug companies is distributing vaccines by the millions a day. This achievement is raising hopes for a return to normal by the end of this year and offers valuable lessons into how to respond to future outbreaks.
“In the last year, Big Pharma has shown it has a real capacity to change our lives for the better,” says Paul MacDonald, Chief Investment Officer & Portfolio Manager at Harvest Portfolios Group Inc. in Oakville, Ontario. “As a result, our attitudes towards drug companies have changed.”
This halo effect, that includes drug companies not directly involved in COVID-19 vaccines, is one of six healthcare energizers Mr. MacDonald sees driving the sector.
For investors, these positive forces add up to an investment opportunity that Harvest captures through its Harvest Healthcare Leaders Income ETF (TSX: HHL, HHL.U. HHL.B). The ETF holds 20 of the largest global healthcare companies, offers growth and income and benefits from Harvest’s covered call strategy which generates extra monthly income. The portfolio is actively managed and rebalanced quarterly.
As at the end of January 2021, the ETF has about 45% of its holdings in pharmaceuticals, including COVID-19 vaccine makers, Pfizer Corp. and Johnson & Johnson Inc. Another 15% are in biotechnology, including Regeneron Pharmaceuticals Inc., another vaccine developer. About 19% are in healthcare equipment and supplies and 14% in healthcare providers.
Mr. MacDonald said at the heart of sector’s strength is the notion that healthcare is a superior good which means we need it in good times and bad. That makes the companies recession-resistant, though not recession proof, with more predictable streams of revenue and profits.
Five other trends favour healthcare:
- Aging populations in developed economies mean that an older demographic is spending more on drugs and surgical procedures. The pandemic has delayed elective procedures, but so the pent-up demand is considerable. “The tone and language on the earnings calls has improved significantly,” Mr. MacDonald said. “People still need these surgeries.”
- Emerging market maturity means more healthcare spending as a portion of GDP. China and India’s healthcare expenditures are growing at a 14% annually, almost triple that of the United States.
- Technological innovation is leading to such things as robot-assisted surgeries, new medical devices and drugs. This means less invasive and less painful surgeries, which means shorter hospital stays with fewer post-surgical complications. Hospitals can therefore perform more surgeries which increase revenues and patients are more likely to opt for the procedures as they are happier with the outcomes.
- Historically low valuations. Stock valuations have shrunk in part because of the pandemic’s impact. Investor have also shifted their focus to high growth sectors such as technology and to more cyclical recovery in areas as mining, banking and manufacturing. “At some point this changes. The cash flows, yields on the dividend side and the prospects for healthcare are very attractive.”
- U.S. election result: The traditional U.S. election year rhetoric died away with the pandemic. A President Biden White House may wish to make big healthcare reforms, but changes will likely be at the margins, Mr. MacDonald said. “The American system is complex with vested interests that make it hard to change things.”
The Harvest Healthcare Leaders Income ETF holds large companies with market capitalizations exceeding US $10 billion. They have wide protective moats with leading products in their fields and strong relationships with their customers. A hidden asset for most is the amount of money spent on research and development. While R&D is written off as an expense, it creates a pipeline of new products. Mr. MacDonald estimates the biotech holdings in the fund – Regeneron, Amgen Inc. and AstraZeneca plc spend an average 20% of revenues on research.
“These companies have long standing businesses with a proven ability to operate through all economic cycles. They offer safety, consistency and income with businesses that are significantly less impacted than others in their sector.”
Mr. MacDonald expects conditions to gradually improve with the resumption of elective surgeries and the launch of new drugs in areas of immunology.
“One of the things everybody really wants to know is when am I going to get a vaccination? We gave some guidance last October that we expected by August or September those wanting to get vaccinated in Canada will be able to. Our view hasn’t changed.”
Mr. MacDonald says that over the medium to long term permanent, non-cyclical growth dynamics are driving the sector, while in the shorter term, gradual economic recovery and a favourable political landscape is creating opportunity. Both are powerful forces.
“The valuations are attractive,” he says. “I see lots of opportunity and great value.”