The noise out of Washington regarding changes to the Affordable Care Act (ACA) and healthcare seems to never end. Despite the lingering uncertainty, there are several longer-term industry trends worth highlighting.
Two key themes that may outlast the headlines are demographics and a renewed emphasis on cost control in healthcare services, in our view. Specifically, let’s look at two healthcare sectors that could see the greatest impacts: biotechnology and managed care.
From an industry perspective biotech occupies a unique hybrid position. It’s both a tech-like sector, offering secular growth potential, and a healthcare sector, with corresponding defensive characteristics. That defensive position came under attack in 2015 as political rhetoric from both sides zeroed in on perceived unfair drug pricing. Nonetheless, there are two factors worth noting regarding biotech that may make this an entry point worth considering:
It is under-owned, and undervalued: Historically, biotech has traded off fundamental drivers: drug pipelines, product growth, mergers and acquisitions (M&A) activity, and patent protection. However, as the 2015 political imbroglio increased drug price uncertainty, investors pulled money broadly out of healthcare. That shift in sentiment has made current valuations more attractive. Over that past 20 years, the price-to-earnings (P/E) ratio of the Nasdaq Biotechnology Index’s has averaged 2.3 times the S&P 500 P/E ratio; today, the current ratio is mere 1.1x, a 53% discount to its 20-year average.1
Long-term drivers appear intact: Drug pipelines are notoriously challenging to predict over the short term, given the deep level of medical knowledge required, clinical testing, and regulatory review. However, two trends appear supportive over the long-term. First, advances in computational biology, bioinformatics, and artificial intelligence (AI) are features helping reduce the time and cost of drug development. Second, approval rates by the U.S. Food and Drug Administration (FDA) have steadily risen over the past two decades, climbing from 23% in 1994 to 89% and 77% in 2014 and 2015, respectively.2 Biotech’s historical drivers currently appear intact, making it one of the rare sectors that enjoys long-term growth potential at a reasonable price.
Biotech currently appears inexpensive on a relative basis