I don’t comment on healthcare services as much as I probably should. I guess it’s fair to say that health service companies are usually not as mediocre as the tech-end of the sector. These companies tend to deliver actual value to patients and sometimes even generate cash.
A novel concept, I know.
As an investment proposition, health services have traditionally been the underdog compared to wow-factor tech-oriented companies, with commensurately lower valuation multiples. But the emergence of large, diversified service providers with significant market capture, provides an interesting way for retail investors to get exposure to healthcare as a growth sector without perhaps the inherent risks of med/biotech product development. Sure, those binary 10x moments aren’t there, but the growth can still be quite decent.
That said, it’s been a tough year for companies like Sonic (ASX : SHL), Primary Health Care (ASX : PRY), Capitol Health (ASX : CAJ) and Integral Diagnostics (ASX : IDX). These companies do have fairly different business models and varying revenue dependency on bulk billing, as outlined by a spate of ASX disclosures in response to the Australian government’s $640m planned cuts to diagnostic bulk billing. However, as the government trims the fat on healthcare expenditure as highlighted in the Federal Government’s Mid-Year Economic and Fiscal Outlook (MYEFO), the pressure is clearly on:
Removing bulk billing incentives for pathology services, aligning bulk billing incentives for diagnostic imaging services with those that apply to general practitioner services and reducing the bulk-billing incentive for magnetic resonance imaging (MRI) services. This measure is expected to reduce cash payments by $197 million in 2016-17 ($639 million over four years to 2018-19).
This may all sound like a recent development, but it really isn’t. All governments watch each other closely (even if ours moves slowly) and “model” healthcare systems in countries like Canada have had the axe out for quite a while – both in terms of billing cost structure and the overall need for diagnostic testing. Radiology procedures are, in general, over-prescribed and our Medicare Benefits Schedule Taskforce has previously suggested that the Ontario Health Technology Advisory Committee’s (OHTAC) cuts to unnecessary medical testing might serve as a prototype for domestic action.
This is not new news.
So, frankly, I don’t see what all the fuss is about. Earnings are going to get impacted by a few percent (the report range from ASX disclosures this past week is 2-7%) but given the generally sophisticated investor profile in these companies, billing pressure has to have been baked into the stock price for a while. Based on widely varying P/Es (recognising that this will be variably useful as a metric relative to company maturity) it is somewhat suggestive that some stocks took a tumble not just because spending cuts put a lens on individual company business models, but because some firms were simply over-priced. As such, there has quite simply been a bit of a correction.
For example, PRY’s price peaked at $5.2 in April and fell as low as $2.20. SHL’s stock peaked at $23.73 in July and fell as low as $17.40 during the week. CAJ, which specialises in bulk-billing, has had a few speed bumps the past few months and was definitely hit the hardest with a fall from $1.11 back in April to around 25c today.
Once the dust settles, some of these equities might be rather interesting because they are all – to a first approximation – mostly decent companies. Revenue pressure will cause them to streamline themselves a bit (and perhaps encourage CAJ to sort out all those acquisitions/partnerships), focus on higher value service segments and also take a more measured view of new technology. Of course, this isn’t the last time that the government is going to make cuts, so this remains an intrinsic risk factor for those firms that have less diversified revenue streams.
However, there is also a major lesson in all of this for the tech-end of the healthcare sector. When healthcare services “sneeze”, reimbursement for new diagnostic technologies gets a “cold”. Therefore, be very skeptical of diagnostic medicine and imaging tech business that paint a rosy picture of the future, but don’t have policy-driven price erosion baked into their stratospheric revenue models. Most Australian ASX-listed diagnostic technology companies do a woeful job of articulating how changes in healthcare policy and reimbursement have the potential to knock them around just as badly as the service-oriented end of the sector.
Here endeth the lesson.
Python image from the “Holy Hand-Grenade of Antioch“. Classic, and a bit of amusement for the day.