An Overview of the Health Care
Industry
JULY 28, 2010
RYAN GREGG
WILLIAM LIUSUDARSO
MELANIE MCFARLAND
CAITLIN MCTIGUE
BRIAN MILLER
Agenda
y Sector Overview
y Business Analysis
y Economic Analysis
y Financial Analysis
y Valuation Analysis
y Recommendation
Sector Overview
y Economic sector concerned with the provision,
distribution, and consumption of health care services
and related products.
y Stocks in the Health Care sector tend to be more
defensive when compared to the broad market. This
is because most products in the sector are more
essential to consumers and have an inelastic demand
curve. This means Health Care products are not
dependent on the direction of the economy.
Source: Investopedia
Sector Overview
y Global Industry Classification Standard (GICS)
Health
Care
Sector
Industry Group
Industry
HC Equipment &
Services
Health Care
Equipment &
Supplies
Health Care
Providers &
Services
Pharmaceuticals
& Biotechnology
Pharmaceuticals
Biotechnology
Source: Standard & Poor’s
Sector Overview
* As of July 22, 2010
Source: Vestek
Sector Overview
S&P 500 Index Sector Breakdown
Materials, 3.4%
Telecom Services,
3.0%
Utilities, 3.7%
Consumer Disc, 10.1%
Info Tech, 18.8%
Consumer Staples,
11.5%
Industrials, 10.3%
Energy, 10.7%
Health
Care, 12.1%
Financials, 16.3%
* As of June 30, 2010
Source: Standard & Poor’s
Sector Overview
* As of June 30, 2010
y Health Care, typically a defensive sector, held up relatively well
in the month of June as stocks sold off on macro concerns and
fears of a double-dip recession. Over the trailing 12 months, we
are still seeing the effects of the high-beta rally from mid-2009
through March 2010. In times where higher-beta stocks
outperform, expect Health Care to lag from their defensive
nature. Health Care reform has also been a large overhang on
recent performance against the broad market S&P 500.
Source: Standard & Poor’s
Growth of the Health Sector
y Demographics affecting growth:
{ Aging population – baby boomers retiring and requiring
more medical care
{ Around 32 million more currently uninsured Americans
will be covered with the new healthcare reform
y Estimated Growth
{ National healthcare spending is predicted to grow 34%
within the next 5 years
{ Public and private healthcare facilities will propel
demand (but not without cost)
Projected Growth in Healthcare Sector
5000
4000
3000
Spending
2000
Year
20
19
20
18
20
17
20
16
20
15
20
14
20
13
20
12
20
11
1000
0
20
10
$ (Billions)
Projected National Healthcare Spend
Pressures on Supply
{
Year
19
20
18
20
17
20
16
20
15
20
14
20
13
20
12
20
11
Payments to doctors
may drop 20%
No incentive to take
Medicare patients
20
{
Percentage
10
Medicaid enrollees
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
20
y Over 18 million new
% of Population Age 65 & Older
%
y More insured patients
{ Large capital investment
requirement to increase
capacity – cost pressures
{ Doctors will be paid less
– 46% have said they
will leave profession if
bill passes
Impact of Health Care Reform
y Increase in insured Americans through expansion of
Medicaid
y Increase in prescription drug use (Closing the
“Donut Hole”)
Ù
Seniors enrolled in Medicare will have assistance and increase the
demand for prescription drugs
y Increase in the utilization of prevention services
Ù
Mandates for insurers to cover certain screenings without copayments
Impact of Health Care Reform
y Lower salaries for doctors
Ù
Medicaid reimbursements are often below cost, students not as
incentivized to enroll in medical school
y Shifting cost structure
Ù
With less reimbursements, industry is likely to incur some of the
increased expenses, shrinking their margins
Five Forces Analysis
Threat of New
Entrants
Buyer Power
Supplier Power
• Barriers to entry are very high
• Large capital investments necessary
•Consumers have little bargaining power over their
own health care
•Varied among Industry, but not significant in
pharmaceuticals and medical devices
Threat of
Substitutes
• Relatively low, no real substitute to health care
Rivalry
• Pharma/Biotech rivalry very intense to be firstto-market with new drugs
Economic Overview
Consumer Spending vs.
Health Care
y
Consumer spending has
tended to correlate well
with health care names.
When discretionary
spending rises, health care
stocks tend to rise with it.
y
Strong consumer spending
is generally a strong
indicator for the market in
general, as consumers are
putting money back into
the economy as opposed
to saving it.
Economic Overview
Consumer Confidence vs.
Heath Care
y
Consumer confidence is a
strong indictor of health
care stock performance.
When consumer
confidence rises,
consumers tend to spend
more money on health
care items, such as
prescriptions, discretionary
surgeries or discretionary
medical devices.
y
Consumer confidence also
is a strong predictor for the
market in general.
Economic Overview
Over the last 5 and 10 Year periods, the aging demographic has not helped
health care stocks.
Economic Overview
Broad Market S&P 500 vs.
Heath Care
y
Over time, health care
names have tended to rise
and fall with the broad
market S&P 500.
Financial Analysis – Health Care Sector
y Operating Earnings Growth Rates:
2008
2009
2010
(Estimate)
2011
(Estimate)
S&P 500
-40%
14.9%
44.4%
15.2%
Health Care Sector
5%
7.9%
12.5%
10.1%
y Sales Growth Rates:
(in millions)
2Q 2010 Sales
Prior Year Sales
% Growth
Gilead Sciences Inc.
$1,927.22
$1,647.15
17.00%
Johnson & Johnson Co.
$15,330.00
$15,239.00
0.60%
Stryker
$1,758.20
$1,634.30
7.58%
Major Sector Companies:
Per www.standardandpoors.com/indices/sp-500
Financial Analysis – Health Care Sector
Net profit margins of the Health Care
sector have been fairly steady over
the last 10 years:
Per THOMSON REUTERS Baseline
Financial Analysis – Health Care Sector
In contrast, the net profit margins of the S&P 500
have been quite volatile, although the most recent
trend is positive.
Per THOMSON REUTERS Baseline
Financial Analysis – Health Care Sector
Other Ratios
y ROE: 16.44%, which is the second highest sector in
the S&P 500, second to only Consumer Goods.
y Price to Free Cash Flow: 3.58, which indicates that
the sector as a whole is generating cash flow. Note
that this ratio is lower than most of the other sectors,
however.
Per Yahoo! Finance
Sector Valuation
• Sector is close to its 10-year low in absolute basis.
• Discounted in its P/E, P/Forward E, P/S, and P/CF to its median level
relative to S&P 500
Biotechnology
Pharmaceuticals
Health Care Distributor
Health Care Managed Care
Health Care Supplies
Industry Comparison in Absolute Basis
Industry’s Comparison discounted by its median
Individual Company Comparison of Health Care Industry
Gilead Sciences
Absolute
Valuation
P/Trailing E
P/Forward E
P/B
P/S
P/CF
Boston Scientific
High
Low Median
Current
281.6
94.4
23.6
33.7
135.4
9.4
9.0
3.9
3.8
8.7
9.4
9.0
3.9
3.8
8.7
30.7
26.4
12.4
13.5
33.4
Abbot Laboratories
Absolute
Valuation
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
Low
Median
Current
29.8
26.5
10.7
6.1
23.4
12.2
10.8
3.5
2.2
8.9
19
17.4
5.1
3.4
14
12.4
11.1
3.6
2.3
9.1
Cardinal Health
Absolute
Valuation
P/Trailing E
P/Forward E
P/B
P/S
P/CF
Absolute
Valuation
P/Trailing E
P/Forward E
P/B
P/S
P/CF
High
Low
Median
Current
68.4
41.6
12.8
11.4
51.6
9.7
10.4
0.6
1.1
5.5
22.2
21.6
3.9
2.7
11.7
14.9
17.1
0.8
1.1
6.3
High
Low
Median
Current
101.6
74.2
3.0
1.4
22.5
5.5
5.5
0.3
0.1
3.0
15.1
13.1
1.4
0.5
11.7
10.2
9.9
1.2
0.3
7.5
High
Low
Median
Current
28.5
24.7
5.1
3.5
24.8
12.3
12.1
2.2
1.6
10.2
21.8
19.6
3.7
2.6
17.4
15.8
15.0
2.4
1.9
12.7
Aetna
Absolute
Valuation
P/Trailing E
P/Forward E
P/B
P/S
P/CF
DENTSPLY International
High
Low
Median
Current
26.6
22.1
5.4
0.7
22.4
6.1
5.9
0.9
0.1
4.8
14.1
12.9
2.4
0.3
11.5
13
14.2
2.3
0.1
9.8
Absolute
Valuation
P/Trailing E
P/Forward E
P/B
P/S
P/CF
Technical Analysis
Recommendation
y Recommendation: Reduce Health Care sector by
2.25% to 11.95% of the SIM portfolio
Recommendations
y Positives
More end-users from Health Care Reform
Ù Valuations
Ù Aging Demographic
Ù
y Negatives
Overhang from Health Care Reform
Ù Cost structures increasing as a result of Reform
Ù
y Uncertainties
Political Party Control
Ù Implementation and Regulations from Reform
Ù
Recommendations
y Bias towards high-quality names with strong
margins and cash flows
y Tend to overweight Pharma & Biotech
y Underweight Medical Devices & Supplies