179. Why COVID has been a genuine catalyst for positive change in the healthcare industry

10 March 2022 (pre-recorded 28 February 2022)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[INTRODUCTION] 

Staci West (SW): Welcome back to the Investing on the go podcast brought to you by FundCalibre. Today, 11^th March 2022, marks the two year anniversary of the WHO declaring a global pandemic. The pandemic has led to major changes not only in our work lives but in the world of health, medicine, and science, some of which are likely to be with us after the virus no longer dominates the daily news headlines. In this episode we explore what’s changed in the healthcare sector from an investor point of view during that time period.

Darius McDermott (DM): I’m Darius McDermott from FundCalibre, today I’m delighted to be joined by James Douglas and Gareth Powell co-managers of the Polar Capital Global Healthcare Investment Trust. Gentleman, good morning, how are you?

James Douglas (JD): Morning Darius, how are you?

[INTERVIEW]

DM: One can’t get away from the sort of dramatic healthcare issues that the planet has suffered in the last two years, I suppose, a very broad question, but you know, the pandemic, how has it changed the healthcare sector? What are you seeing apart from sort of the focus on it, that is different?

JD: Yeah, I’ll take that Darius, it’s James. I mean, it’s been an extraordinary period of time as I’m sure everyone can appreciate, but we actually think that the COVID-19 pandemic has been a genuine catalyst for positive change in the healthcare industry. And I think there’s probably three areas worth mentioning.

So firstly, this idea that the delivery of healthcare is being disrupted and what do we mean by that? Essentially we believe there has been and will continue to be an acceleration of shifting patient volumes away from hospitals to lower cost settings, such as surgery day centers in the home. And that’s clearly a benefit not just to patients, but also those who have paying the bills. So that’s one area, secondary area would be prevention. I hope most people appreciate the potential value of a safe and effective vaccine, but actually we are also referring to a rapid acceleration in diagnostics infrastructure and that really could lead to broader testing menus and greater adoption of diagnostics. And that’s potentially in important because if you can get a patient diagnosed early, you can get them on the right treatment path, then you can potentially drive better outcomes for the patient and hopefully some economic savings for the healthcare systems. 

And then finally, another area that has accelerated is outsourcing. And this is accelerated in areas like clinical trials and contract manufacturing. So you may be a company like a pharmaceutical company, for example, you want to outsource non-core activities, retain financial flexibility – and two areas that we believe that has happened and we think will be durable is both clinical trials and the outsourcing of things like contract manufacturing and manufacturing devices. And so those we think have really accelerated in the last 18 to 24 months. And importantly, as I mentioned before we don’t think they’re short lived and we think they could deliver durable medium-term growth.

DM: So another, a fairly well discussed fallout if you like, has been the sort of shares that have done well in COVID and the shares that have then gone on, maybe in some instances to do badly. We are recording on a certain platform today called Zoom and they’ve had their ups and their downs like Peloton and the biotech sector and healthcare sector, I suppose, has been the same. 

Moderna, obviously one of the vaccine suppliers, has fallen around 70% from its peak and Teledoc by a similar amount. Does this look like some of those healthcare winners are durable or that they’re giving up some of maybe some excess returns over a short period of time?

Gareth Powell (GP): Yeah. Hi Darius. It’s a really good question. And, you know, obviously we’re looking at how far these things are fallen and, you know, you sort of think whether they’re worth looking at and, you know, we’re clearly following them. I mean, they got to pretty incredible valuations. So Moderna at its high, you know, was near $200 billion in market cap and that was bigger than AstraZeneca and Sane at the time. So it was quite remarkable and Teledoc similarly got put on a very high multiple, so we almost feel like the sort of “COVID winners,” if there is such a thing. I don’t know if that’s a great way of saying it, but in inverted comas, they did get very expensive. You saw a lot of flows into those types of stocks. You know, you highlight Zoom, obviously Peloton, you know, there’s lots of things you can think of.

And then, you know, sort of rightly they’ve come down a lot. I think, you know, if you look at the typical price behavior, when you’ve had a bubble you get these stocks if you look back on multiple cycles, they fall a long way. You have sort of strong bounces along that decline. And then over a period of time, the stocks really don’t do very much. So, you know, people tend to call it a consolidation and this can go on for years, but we think, you know, underlying there’s value ultimately in Moderna with its mRNA technology and, you know, Teledoc has achieved a lot with its telemedicine access. But, you know, I guess, you know, similarly following the collapse of a bubble, you would expect a similar sort of period of consolidation here. And then, you know, the opportunities might get more exciting again after a period of time.

DM: Yeah. Another word, which we can’t escape as we sit here in early March 2022 is inflation. I know you guys have attended the recent JP Morgan healthcare conference. Are there any subsectors that benefit from these high inflation within your sort of overall healthcare remit and what have you been hearing from companies about their supply chain issues? Are they improving now as we sit here today?

JD: Yeah. So I mean, what we have learned is not all companies have created equal and they’ve all got different challenges and different levels of vertical integration. But I would say on the kind of like on the cautious side, the medical device subsector has seen a bit of pressure, particularly how they’re talking about forward looking margins and that’s coming in areas such as electronic components. So we all know there’s a semiconductor shortage, things like resins and steel and actually freight costs, you know, it’s just physically shipping their products around. So that has been a bit of a challenge. 

The other challenge we have seen is on the wage inflation side and that’s particularly pertinent in areas like hospitals and services, where obviously you need a high level of staffing to look after patients. So that has been a challenge. We think it’s been exaggerated by COVID. So hopefully if we go beyond pandemic and move to more epidemic, some of those pressures should ease. 

On the other side some of the supply companies and so we’re talking about areas like ophthalmology, dental, they have an ability to pass on some of these pressures. So they’re less effective in the medium term. You know, you can get quarterly variations between cost and passing on, but longer term I think they should be able to pass some of these on. So, so that’s a bit more encouraging. And I think on other areas of healthcare, such as pharmaceuticals, biotechnology on the insurance side, it’s just slightly less relevant. 

So I think in conclusion we’re probably better equipped and a bit more immune than some other sectors within the market, but we’re certainly not 100% protected. 

GP: Darius, I think, you know, just briefly adding to that on a historical perspective, you know, Jamie’s talked about really the fundamentals and what we’re seeing, from a historical perspective with healthcare stocks when inflation is increasing. It tends to struggle as a source of funds for things like energy as you’d expect. But once that, you know, and we kind of expect inflation to continue to move higher, but at some point that rate of change is going to slow. Healthcare companies, product companies, whether it’s biotech, pharma, med tech, which dominate our industry, they have very high gross margins and operating margins typically, so they can manage those pressures. 

So I think what the markets moved onto is understanding operational effectiveness, or efficiency, real scrutiny on margins. And actually even if inflation stays high, but as peaked in its rate of change, large cap healthcare can do really well. And so that’s interesting. And then, you know, if inflation does slow, we would expect, you know, the healthcare sectors will actually do very well and be you know, would draw back in those funds that moved away when inflation was increasing.

DM: That’s really interesting. I think that’s, you know, good for people to understand, not every sector is anti-inflation or pro inflation easily. Sometimes they lag sometimes they lead. But yeah, that’s really interesting. 

So another major topic when we talk about healthcare is the US electoral cycle. I live in the UK and we follow US selections from afar, but healthcare normally tops the agenda, or at least is always on the, it’s on the front page of the paper let’s just say that. We’re around halfway through Joe Biden’s administration, has he had much of an impact on the healthcare sector or were you not expecting much of an impact from him, has the rhotic been quite low?

JD: I think there’s two areas, clearly COVID 19 and the public health emergency has been front and center for a lot of people globally, but particularly in the US. So if we just kind of put that to one side, I think the biggest area of focus for the Biden administration has been expanding access to the affordable care act. And just as a quick reminder for the listeners President Obama introduced something called the affordable care act or the ACA back in 2010 and really Biden’s ministry team have really been focused on bolstering that. And so that includes improving access essentially to US systems who have quite low incomes. And so that’s been his biggest focus. 

In terms of drug pricing, which is something that always comes out. It really was a focus for the markets last year. Particularly when he was talking about his huge build back better stimulus, because within that contains some details around drug pricing. But actually we think that’s slowly dissipating. The reason we say that is BBB or the build back better has been slightly diluted. And within that one would expect some dilution of the healthcare policies, but actually more importantly that we’re heading towards the midterms. And if indeed the Republicans gain grounds in the House of Representatives, what we could face ourselves with is essentially legislative gridlock. In other words, the chances of the administration getting anything really draconian through on drug pricing become a wee bit lower. 

And so in conclusion, I would say that the status quo is broadly supportive. I think that the focus on the ACA will continue. And I think that anything really, really far reaching on the drug pricing size is less likely now than maybe it was 6 to 12 months ago.

DM: I suppose people think of healthcare they think of large cap pharma, but as we know, it’s far broader than that, you have a number, a wide number of sub sectors, obviously pharma being the biggest, but biotech and devices and, you know, the whole tele doctor side. But which areas or which sub sectors are you finding most exciting today and, you know, where you generally expect to make decent upside over the next 12, 20 months?

GP: Yeah, so, I mean, if you really drill down, there’s more than probably more than 40 difference sub sectors within healthcare. So, you know, I mean, as you say, you know, pharma, MedTech, biotech, the big caps dominate, but there’s so much going on the surface today what we are excited about, there’s three different areas. 

So first, so there’s kind of a link. So firstly dealing with the enormous backlog of sort of healthcare procedures and, or utilization and then prevention which Jamie’s talked about a bit earlier and the last bits biotech. So just briefly on each of those. With COVID there’s been a significant backlog build up and, you know, I’m sure you’ve read this in the news in the UK – elective procedures, oncology, diagnostic testing, dermatology, and this has impacted a number of different areas of healthcare. 

So we’re taking the optimistic view on the COVID situation. And if that does sort of continue to be the case, you could end up with a rate of infections that’s very low, so that could allow the healthcare system to kind of deal with the backlog if you like. And so we feel that that backlog is big. Healthcare utilization could really, really pick up as people have confidence going back into healthcare systems and healthcare systems can cope with a situation where they’re not having to cope with, deal with heavy COVID infection rates. And so, you know, if that does come through, that’s going to help, that’s going to really support growth in health, medical devices, healthcare supplies and, you know, strangely also in areas like pharmaceuticals, where normally you don’t think about much sort of cyclicity, but, you know, COVID is very different, right. You know, some of the, whether reps at pharma companies being able to see doctors, you know, that’s been really limited certain areas. You know, I mentioned oncology and dermatology, you know, volumes have been significantly impacted there and that’s really impacted utilization of pharmaceuticals as well. 

So it’s quite broad based actually, but I think, you know, there’s a very powerful potential for pickup and growth, particularly in med tech, medical devices and healthcare supplies. Prevention. Obviously we’re talking about diagnostics in the main here. You know, and again, utilization, you know we’ve seen a drop off in diagnostic testing, I think in the UK press last week was about breast cancer testing screening. I think over the COVID, over the pandemic phase over the last two years, a million appointments have either been cancel or missed, you know, that’s huge number you know, and sadly probably, you know, diagnosis will have been missed. So hopefully that can come back. So they’re two really big on that utilisation themes. And then lastly, just on biotech.

DM: I love a bit of biotech, Gareth you know that.

GP: Large cap phrama, it’s held up pretty well with a large cap pharma actually, you having done quite well strangely over the last 12 months that wasn’t really expected, but, or maybe last last nine months or so. But small midcap has been hit extremely hard. If we look at historical trends on valuation, they’re looking pretty attractive on measures such as price to cash, and you know, what we think the potential a potential catalyst we’re not really necessarily calling the bottom on the space, but a potential catalyst could be a pickup in M&A. 

So if you look in the second half of last year, particularly on a basically look on a, a sort of a comparison to the last 20 years, M&A a activity was extremely quiet in pharma and biotech, we think there are a number of reasons. I won’t elaborate on that, but the point is we think the big guys, so the big pharma companies, the big biotechs, you know, if you look at most recent reporting management teams of those big companies have been actively saying, they’ve noted the big pullback in the biotech sector, and they’re looking at opportunities to consolidate companies and assets for their own pipelines. And so, yeah, that could be a catalyst help out here because you know, the group is, you know, we’ve been investing in biotech for over 20 years and the group is definitely in the out of favor camp, in line with other periods where that’s been the case. So that is, I think interesting is kind of an anecdote if you like.

DM: Yeah, well, it is actually interesting because we all sit in a world where let’s be honest, lots of things look expensive, from government bonds all the way to, well certainly high of growth equities did look expensive six months ago, but maybe slightly less so as we’ve already touched on today, but hearing that the likes of biotech as a subsector and the mid small cap area of it looks historically cheap is interesting. 

So look guys one last question for either, ither, or maybe both of you, is there one thing that the pandemic has changed either in your view to the healthcare sector or the way you invest in it or things that you’ve learned. I don’t mean changes to the process specifically, but just any little snippets that you may have picked up looking back on the two years since pandemic was sort of formally recognised. 

JD: Yeah, it’s a fair question and pinning it down to one thing is obviously quite difficult cause it’s been a pretty remarkable period, not just within, but for all of us. 

DM: Yeah. 

JD: And challenging and I think the resilience that everybody has shown has been pretty impressive. From healthcare perspective. I mean, think the one, the one word I would maybe focus on is innovation. To get the DNA of the virus in early 2020, and then to have an approved or sorry, emergency approval for the vaccine within a 12 month period is pretty remarkable.

DM: Yeah.

JD: Actually the other really impressive thing I think is that coordination and mobilization and resources corporation between corporates and regulatory authorities. And it’s not just pharmaceuticals and vaccines, it’s life sciences and tools. You know, they’ve all done a terrific job. And I think the reason I mentioned that is that touch wood, we won’t get another variant that creates havoc. But if we do, I think there’s confidence that the healthcare system will find a solution so we can all function as a society. So that would be my hope. And certainly I think innovation is a word that should be synonymous with healthcare. 

GP: Yeah. And Darius. I mean, you know, I just totally agree. I mean, I can’t think of anything else, you know, in the last two years, or 12 months, you know,  I think the speed is, you know, just remarkably you think about traditionally, if you start from scratch, a vaccine, you’ve got a 6% chance of success and it takes 10 years. 

DM: Yeah. 

GP: You know what this started from scratch kind of. And it took nine months, you know, to get a vaccine I think, sort of into people. So it’s just incredible. And I mean, you know, thankfully, you know, we’ve got broad up well and building more significant access to vaccines, COVID vaccines.

DM: James, Gareth, thank you so much for talking us through a sector and you know, global healthcare is a broad sector, but it must have been a fascinating time. And just your finishing answer there about the speed of getting that vaccine but you know, built, tested, and approved and then delivered has been absolutely phenomenal. 

SW: It’s been an interesting time for investors around the globe, least not those in the healthcare space. The managers of the Polar Capital Global Healthcare Trust have been investing in this space for over a decade. This is a unique trust investing in a very specialist part of the stock market. The trust invests in a healthcare stocks from around the globe. These companies will predominantly come from four sub-sectors: pharmaceuticals, biotechnology, medical technology and healthcare services. To learn more about the Polar Capital Global Healthcare Trust visit fundcalibre.com – and don’t forget to subscribe to the Investing on the go podcast, available wherever you get your podcasts. 

Please remember, we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at the time of listening. Elite Ratings are based on FundCalibre’s research methodology and are the opinion of FundCalibre’s research team only.