By Paul Rickard 

With momentum investing all the rage, a previous darling, the healthcare sector, has turned somewhat sick. The sector lost 8.3% in October, and after two down days in November, is now marginally in the red for 2016. After strong outperformance in 2012, 2013, 2014, 2015, it has noticeably pulled back over the last few months.

The following graph shows the S&P/ASX 200 accumulation index and the healthcare sector index, using a common base of 100 on 1 November 2011. Over the last five years, the healthcare sector has returned 188%, or almost 3.5 times the broader market’s 55%. However, since peaking on 25 July, the healthcare index has lost 14.9% (to 2 November) compared to the broader market’s 5.2%.

 

Source: S&P Dow Jones Indices

So, why the pullback, and is there any value to be found?

Part of the reason is the performance of the US markets, where the healthcare index is down by 5.7% this year compared to the overall market’s return of plus 5.2%. Since the start of the quarter, while the S&P 500 has lost 2.5%, the healthcare index has dropped by almost 7%. While the US has some unique political reasons for the fall, with a possible Clinton administration viewed as being bad for the major pharmaceutical companies among others, where the US goes, we tend to follow.

Next, a couple of our health companies have met tough times. Aged care provider Estia Health (EHE) has been in real strife, while hospital operator Healthscope updated guidance and talked  about “slower than expected revenue growth in the first quarter”, suggesting that “operating EBITDA growth for the hospitals business would be flat year on year”. It got hammered, and has dropped by almost 27% since announcing this on 20 October.

The third reason is not new, but has gained more traction over the last few months. Many fund managers say that our health care sector is simply expensive, with several stocks trading on multiples in the high twenties. By comparison, multiples in Europe and America are often in the high teens. According to Yardeni Research, the S&P 500 healthcare sector is trading on a 12 month forward PE of 14.5 times, less than the multiple for the market as a whole of 16.6 times.

So, is there any value in health care stocks? Well, a sell-off creates opportunity for buyers and while there is little to suggest that the momentum selling has stopped, there has been no change to the incredibly powerful industry tailwinds. These are: an ageing population; increasing demand per person for health services; and government spending on health growing each year at a margin over nominal GDP growth. While Governments across Australia will make noise about new regulations to reign in these costs, they are still forecasting growth at around 6% to 7% pa.

Timing in markets is everything, but you do have to buy when others want to sell. Here are some top stocks to put on your buy list.

1. Ramsay Health Care (RHC)

Australia’s largest operator of private hospitals, Ramsay Health Care, reported core net profit of $481.4 million for the year ended 30 June 2016, a 16.8% increase on the previous corresponding period. Core earnings per share (EPS) grew by 17.7%. (You can read more about Ramsay’s full year result here.)

Ramsay peaked on the ASX on 1 September at $84.08, shortly after announcing its results. It closed on Wednesday at $71.52. 

Ramsay Health Care (RHC) 

Source: Yahoo!7 Finance

Following Healthscope’s admission that revenue was flat, Ramsay reaffirmed its guidance for FY17 on 26 October. It said that “FY17 first quarter results are in line with its expectations and reaffirms that it is targeting Core NPAT and Core EPS growth for the Group of 10-12% for FY17”.

According to FNArena, the major brokers have Ramsay trading on a multiple of 27.7 times FY17 earnings, and 24.6 times FY18 earnings. The consensus target price is $81.03, a 13.3% premium to Wednesday’s closing price.

2. CSL Limited (CSL)

CSL has been somewhat of a laggard recently, and it is now trading below where it started the year. Wednesday’s close of $97.49 was 19.6% below its peak of $121.25 set on 25 July.

CSL Limited (CSL)

 

Source: Yahoo!7 Finance

Australia’s largest healthcare stock, CSL, had sales in FY16 of US$6.1bn, generating NPAT of US$1.24bn. Through CSL Behring, it is the world leader in blood plasma products, and has recently acquired the loss making Seqirus flu vaccine business to become number two globally in this market.

At its recent AGM, CSL reaffirmed guidance for FY17, that is, NPAT growth of around 11% in constant currency terms, EBITDA growth of around 14% in constant currency, and EPS growth to exceed NPAT growth.

The brokers have CSL trading on a multiple of 26.8 times FY17 and 21.9 times FY earnings (using current FX rates). They are in the main neutral, citing concerns over the Seqirus acquisition. The consensus target price is $110.20, a 13.0% premium to yesterday’s closing price.

3. Cochlear (COH)

Hearing implant, product and services group Cochlear has enjoyed a stellar run in 2016. Financially, it reported sales revenue up 12% in constant currency terms, and net profit up 30% to $189m.

On the market, it started the year at $95.58, peaking on 26 August at $144.12. Yesterday, it closed at $124.70, some 13.5% below its peak.

Cochlear Limited (COH)

Source: Yahoo!7 Finance

The management of Cochlear has guided for a net profit for FY17 in the range of $210-$225m, up by 10-20% on FY16. 

According to FNArena, the major brokers have Cochlear trading at the heady multiple of 32.5 times FY17 forecast earnings, and 28.5 times FY18 earnings. The consensus target price of $122.08 is a 2.1% discount to Wednesday’s closing price. Sentiment is neutral. 

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.